Monetary Policy

Monetary Policy

Monetary policy refers to changes made by the central bank to interest rates, quantity of money in order to achieve changes in aggregate demand that keeps inflation in target.

Objectives

Price Stability

Full employment

Economic growth

Exchange stability

Financial stability

Price Stability

Control the general price level in the economy (inflation).

So monetary policy seeks both inflation and deflation in the economy.

Full Employment

Refers to the situation where all people are able to work and willing to work.

Economic Growth

Economic growth refers to the sustained rise in the income per capita.

Exchange stability

This refers to regulate foreign exchange reserve in order to control supply and demand.

Financial stability

Making sure banks and financial institutions do not collapse.

Types

Expansionary

Contractionary

Expansionary

During times of slowdown or a recession, an expansionary policy supports economic activity. By lowering interest rates, saving becomes less attractive, business and consumer borrowing increases, as does business and consumer spending.

Contractionary

A contractionary policy increases interest rates and limits the outstanding money supply to slow growth and decrease inflation, where the prices of goods and services in an economy rise and reduce the purchasing power of money.

Tools

OMO

Interest rates

Discount rates

Interest of reserves

Reserve requirements

Quantitative Easing QE

OMO

In open market operations (OMO), the Fed buys bonds from investors or sells additional bonds to them to increase or reduce the money available to the economy as a whole.

Selling or buys government securities to control the amount of money circulating.

Interest Rates

By lowering or raising the base interest rate, the central bank influences how much is borrowed or spent.

Interest on Reserves

The policy provides interest on reserves to commercial banks for keeping their excess reserves with the central bank.

Reserve Requirements

Deciding how much money a commercial bank must keep in reserve and not lend out.

Discount rates

Same as interest rates.

QE

QE is shorthand for an unconventional Federal Reserve policy that involves buying up large quantities of financial assets

Quantitative easing (QE) is when a central bank increases money supply to encourage banks to lend at cheaper rates, stimulating demand.