Monetary Policy

Monetary policy is the process by which the government, central bank, or monetary authority of a country controls

  1. the supply of money,
  2. Availability of money, and
  3. Cost of money or rate of interest,

in order to attain growth and stability of the economy.

Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy.

An expansionary policy increases the total supply of money in the economy and is traditionally used to combat unemployment in a recession by lowering interest rates.

Contractionary policy decreases the total money supply and involves raising interest rates in order to combat inflation.

It is argued that an increase in the money supply causes an increase in the rate of inflation. Maintaining a low and stable inflation is one of the main macroeconomic objectives of the Government. Government does so by controlling the supply of money to the economy. This policy is known as monetary policy.

Monetary policy is concerned with controlling the supply of money and the interest rates in the economy. The government cannot control both the supply of money and interest rates at the same time.

Monetary policy in any country is usually controlled by the Central Bank of that country. The Central bank alters the interest rates in the economy after assessing the inflationary pressures in the market.

Evaluation of Monetary Policy

Monetary policy is considered to be more successful during inflationary times because an increase in interest rates reduces the borrowings and thus stabilises the prices. Whereas, during deflation, Monetary policy may not be as effective. During deflation or recession, there is uncertainty in the market which discourages entrepreneurs and producers to take risk.

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