{"id":270100,"date":"2024-06-30T08:00:49","date_gmt":"2024-06-30T08:00:49","guid":{"rendered":"https:\/\/www.techopedia.com\/?post_type=definition&#038;p=270100"},"modified":"2024-06-30T08:00:48","modified_gmt":"2024-06-30T08:00:48","slug":"monetary-policy","status":"publish","type":"definition","link":"https:\/\/www.techopedia.com\/definition\/monetary-policy","title":{"rendered":"Monetary Policy"},"content":{"rendered":"<h2><span id=\"what_is_monetary_policy\">What is Monetary Policy?<\/span><\/h2>\n<p>Monetary policy is a series of actions taken by a country&#8217;s <a href=\"https:\/\/www.techopedia.com\/definition\/central-bank\">central bank<\/a> to maintain a stable economy and employment with the use of various tools such as <a href=\"https:\/\/www.techopedia.com\/definition\/interest-rate\">interest rates<\/a> and asset purchasing.<\/p>\n<p><img decoding=\"async\" src=\"https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Monetary-Policy-300x190.jpg\" alt=\"What is Monetary Policy?\" width=\"1200\" height=\"760\" class=\"aligncenter wp-image-270104\" srcset=\"https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Monetary-Policy-300x190.jpg 300w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Monetary-Policy-1024x649.jpg 1024w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Monetary-Policy-768x486.jpg 768w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Monetary-Policy-1536x973.jpg 1536w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Monetary-Policy-2048x1297.jpg 2048w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Monetary-Policy-1200x760.jpg 1200w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Monetary-Policy-1980x1254.jpg 1980w\" sizes=\"(max-width: 1200px) 100vw, 1200px\" \/><\/p>\n<p class=\"p1\"><div class=\"su-note\"  style=\"border-color:#e5e54c;border-radius:\u201c3\u201dpx;-moz-border-radius:\u201c3\u201dpx;-webkit-border-radius:\u201c3\u201dpx;\"><div class=\"su-note-inner su-u-clearfix su-u-trim\" style=\"background-color:#FFFF66;border-color:#ffffff;color:#333333;border-radius:\u201c3\u201dpx;-moz-border-radius:\u201c3\u201dpx;-webkit-border-radius:\u201c3\u201dpx;\">\n<h2><span id=\"key_takeaways\">Key Takeaways<\/span><\/h2>\n<ul>\n<li>Monetary policy is managed by a country&#8217;s central bank.<\/li>\n<li>Interest rates can be increased to support economic growth and decreased to manage <a href=\"https:\/\/www.techopedia.com\/definition\/inflation\">inflation<\/a>.<\/li>\n<li>In the United States, the <a href=\"https:\/\/www.techopedia.com\/definition\/federal-reserve-fed\">Federal Reserve<\/a> manages the country&#8217;s monetary policy.<\/li>\n<li>Monetary policy can help stabilize the economy without the need for legislative changes.<\/li>\n<li>Policy changes can take months or years to be fully felt in the economy.<\/li>\n<\/ul>\n<p class=\"p1\"><\/div><\/div>\n<h2><span id=\"types_of_monetary_policy\">Types of Monetary Policy<\/span><\/h2>\n<p>Based on the monetary policy definition, there are two main types of policies: expansionary and contractionary.<\/p>\n<p><strong>Expansionary monetary policy<\/strong> is used to stimulate an economy that is slowing down or in a recession.<\/p>\n<p>On the flipside, <strong>contractionary monetary policy<\/strong> is used to cool down an overheated economy that is running high inflation.<\/p>\n<h2><span id=\"monetary_policy_goals\">Monetary Policy Goals<\/span><\/h2>\n<p>The main goal of monetary policy is to balance full employment and inflation. When monetary policy is used to grow the economy, there&#8217;s a risk of increasing inflation.<\/p>\n<p>On the other side, when monetary policy is used to manage inflation, it can slow the economy and risk a recession. Therefore, monetary policy decisions must balance these two opposing forces to maintain economic stability.<\/p>\n<h2><span id=\"tools_of_monetary_policy\">Tools of Monetary Policy<\/span><\/h2>\n<p><img decoding=\"async\" src=\"https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-Monetary-Policy-Tools-237x300.jpg\" alt=\"Tools of Monetary Policy\" width=\"600\" height=\"760\" class=\"aligncenter wp-image-270106\" srcset=\"https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-Monetary-Policy-Tools-237x300.jpg 237w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-Monetary-Policy-Tools-808x1024.jpg 808w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-Monetary-Policy-Tools-768x973.jpg 768w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-Monetary-Policy-Tools-1213x1536.jpg 1213w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-Monetary-Policy-Tools-1617x2048.jpg 1617w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-Monetary-Policy-Tools-1200x1520.jpg 1200w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-Monetary-Policy-Tools-1980x2508.jpg 1980w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-Monetary-Policy-Tools-scaled.jpg 2021w\" sizes=\"(max-width: 600px) 100vw, 600px\" \/><\/p>\n<p>The main tool of monetary policy is <strong>interest rates<\/strong>, which central banks use to increase or decrease the cost of borrowing money. As interest rates rise, it becomes more expensive to borrow, and instead, businesses slow down their growth. This also incentivizes more savings and reduces economic growth. When interest rates are lowered, businesses are incentivized to borrow and grow and, in turn, hire more employees, which helps reduce unemployment and grow the economy.<\/p>\n<p>Monetary policy can be used to buy and sell government <a href=\"https:\/\/www.techopedia.com\/definition\/securities-market\">securities<\/a> such as <a href=\"https:\/\/www.techopedia.com\/definition\/bond\">bonds<\/a>, known as <strong>open market operations<\/strong>. When a central bank purchases securities, it injects capital into the economy to spur growth. When it sells securities, it removes money from the economy to help manage inflation.<\/p>\n<p>A final tool that central banks can use is to <strong>change the reserve ratio required for banks<\/strong>. The reserve ratio is the percentage of deposits that banks must hold as reserves. If this ratio is lowered, banks can lend out more capital and jumpstart economic growth. When the reserve ratio is raised, banks must hold more cash, taking it out of the economy and lowering growth as a result.<\/p>\n<h2><span id=\"expansionary_monetary_policy_vs_contractionary_monetary_policy\">Expansionary Monetary Policy vs. Contractionary Monetary Policy<\/span><\/h2>\n<p class=\"p1\"><div class=\"su-tabs su-tabs-style-default su-tabs-mobile-stack su-tabs-vertical\" data-active=\"1\" data-scroll-offset=\"0\" data-anchor-in-url=\"no\"><div class=\"su-tabs-nav\"><span class=\"\" data-url=\"\" data-target=\"blank\" tabindex=\"0\" role=\"button\"><strong>Expansionary Monetary Policy<\/strong><\/span><span class=\"\" data-url=\"\" data-target=\"blank\" tabindex=\"0\" role=\"button\"><strong>Contractionary Monetary Policy<\/strong><\/span><\/div><div class=\"su-tabs-panes\"><div class=\"su-tabs-pane su-u-clearfix su-u-trim\" data-title=\"&lt;strong&gt;Expansionary Monetary Policy&lt;\/strong&gt;\">\n<p class=\"p1\"><strong>What is it?<\/strong> Actions to increase the money supply and reduce interest rates<\/p>\n<p class=\"p1\"><strong>Goals<\/strong>: Stimulate economic growth and reduce unemployment<\/p>\n<p><strong>Money supply<\/strong>: Increases<\/p>\n<p><strong>Interest rates<\/strong>: Decrease<\/p>\n<p><strong>When is it used?<\/strong> A slowing economy facing a recession<\/p>\n<p><strong>Risks<\/strong>: Currency devaluation and rising inflation<\/p>\n<p class=\"p1\"><\/div>\n<div class=\"su-tabs-pane su-u-clearfix su-u-trim\" data-title=\"&lt;strong&gt;Contractionary Monetary Policy&lt;\/strong&gt;\">\n<p class=\"p1\"><strong>What is it?<\/strong> Actions to decrease the money supply and increase interest rates<\/p>\n<p class=\"p1\"><strong>Goals<\/strong>: Manage rising inflation and stabilize the local currency value<\/p>\n<p><strong>Money supply<\/strong>: Decreases<\/p>\n<p><strong>Interest rates<\/strong>: Increase<\/p>\n<p><strong>When is it used?<\/strong> An overheated economy with rising inflation<\/p>\n<p><strong>Risks<\/strong>: Rising unemployment and slower economic growth<\/p>\n<p class=\"p1\"><\/div><\/div><\/div>\n<h2><span id=\"monetary_policy_vs_fiscal_policy\">Monetary Policy vs. Fiscal Policy<\/span><\/h2>\n<p class=\"p1\"><div class=\"su-tabs su-tabs-style-default su-tabs-mobile-stack su-tabs-vertical\" data-active=\"1\" data-scroll-offset=\"0\" data-anchor-in-url=\"no\"><div class=\"su-tabs-nav\"><span class=\"\" data-url=\"\" data-target=\"blank\" tabindex=\"0\" role=\"button\"><strong>Monetary Policy<\/strong><\/span><span class=\"\" data-url=\"\" data-target=\"blank\" tabindex=\"0\" role=\"button\"><strong>Fiscal Policy<\/strong><\/span><\/div><div class=\"su-tabs-panes\"><div class=\"su-tabs-pane su-u-clearfix su-u-trim\" data-title=\"&lt;strong&gt;Monetary Policy&lt;\/strong&gt;\">\n<p class=\"p1\"><strong>What is it?<\/strong> Decisions to control the money supply and interest rates<\/p>\n<p class=\"p1\"><strong>Managed by\u2026<\/strong> Central banks<\/p>\n<p><strong>Goals<\/strong>: Manage inflation and employment<\/p>\n<p><strong>Main tool<\/strong>: Interest rates<\/p>\n<p><strong>In a recession\u2026<\/strong> Reduce interest rates and purchase securities<\/p>\n<p><strong>In an inflationary environment\u2026<\/strong> Increase interest rates and sell securities<\/p>\n<p class=\"p1\"><\/div>\n<div class=\"su-tabs-pane su-u-clearfix su-u-trim\" data-title=\"&lt;strong&gt;Fiscal Policy&lt;\/strong&gt;\">\n<p class=\"p1\"><strong>What is it?<\/strong> Decisions to manage taxes and government spending<\/p>\n<p class=\"p1\"><strong>Managed by\u2026<\/strong> Governments and legislatures<\/p>\n<p><strong>Goals<\/strong>: Redistribute income and stimulate economic growth<\/p>\n<p><strong>Main tool<\/strong>: Government spending and taxes<\/p>\n<p><strong>In a recession\u2026<\/strong>\u00a0 Increase spending and decrease taxes<\/p>\n<p><strong>In an inflationary environment\u2026<\/strong> Decrease spending and increase taxes<\/p>\n<p class=\"p1\"><\/div><\/div><\/div>\n<h2><span id=\"monetary_policy_pros_and_cons\">Monetary Policy Pros and Cons<\/span><\/h2>\n<p class=\"p1\"><div class=\"su-row\"><div class=\"su-column su-column-size-1-2\"><div class=\"su-column-inner su-u-clearfix su-u-trim\">\n<h3 class=\"p1\"><b>Pros<\/b><\/h3>\n<p class=\"p1\"><div class=\"su-list\" style=\"margin-left:0px\">\n<ul>\n<li><i class=\"sui sui-check-circle\" style=\"color:#3CB371\"><\/i> Can be helpful to curb inflation and stabilize the economy<\/li>\n<li><i class=\"sui sui-check-circle\" style=\"color:#3CB371\"><\/i> Monetary policy changes can be enacted fairly quickly<\/li>\n<li><i class=\"sui sui-check-circle\" style=\"color:#3CB371\"><\/i> Central banks are usually independent of the political system and can make unbiased decisions<\/li>\n<li><i class=\"sui sui-check-circle\" style=\"color:#3CB371\"><\/i> Economic stability can be gained from predictable monetary policy changes<\/li>\n<\/ul>\n<p class=\"p1\"><\/div><\/div><\/div>\n<p class=\"p1\"><div class=\"su-column su-column-size-1-2 pros_icons_\"><div class=\"su-column-inner su-u-clearfix su-u-trim\">\n<h3 class=\"p1\"><b>Cons<\/b><\/h3>\n<p class=\"p1\"><div class=\"su-list\" style=\"margin-left:0px\">\n<ul>\n<li><i class=\"sui sui-remove\" style=\"color:#e31f28\"><\/i> May not be enough to control economic problems<\/li>\n<li><i class=\"sui sui-remove\" style=\"color:#e31f28\"><\/i> It can take months or even years for monetary policy changes to impact the economy<\/li>\n<li><i class=\"sui sui-remove\" style=\"color:#e31f28\"><\/i> When interest rates are already low, central banks are limited in what they can do to spark economic growth<\/li>\n<li><i class=\"sui sui-remove\" style=\"color:#e31f28\"><\/i> Inflating asset prices with economic stimulus can disproportionately benefit financial asset owners, leading to greater financial inequality<\/li>\n<\/ul>\n<p class=\"p1\"><\/div><\/div><\/div><\/div>\n<h2><span id=\"the_bottom_line\">The Bottom Line<\/span><\/h2>\n<p>Monetary policy actions can help central banks maintain economic stability. Monetary policy, meaning the management of interest rates and money supply, is a crucial tool in this effort. Because central banks are generally independent from political parties, they can operate without bias and in the best interest of the economy as a whole.<\/p>\n<p>While monetary policy changes aren&#8217;t a cure-all for economic issues and can take months or even years to take full effect, they are often useful tools to manage inflation, employment, and keep the economy running smoothly.<\/p>\n<h2><span id=\"faqs\">FAQs<\/span><\/h2>\n<div class=\"man_faq_sec\" itemscope itemtype=\"https:\/\/schema.org\/FAQPage\"><section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">What is monetary policy in simple terms?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">Monetary policy is used by central banks to manage the steady growth of an economy while keeping prices and employment stable. <\/p>\r\n                <\/div><\/div><\/section>\n<section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">What is an example of a monetary policy?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">Interest rate changes and management of government securities are both examples of monetary policy. <\/p>\r\n                <\/div><\/div><\/section>\n<section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">What is the main goal of monetary policy?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">Monetary policy is used to manage inflation, employment, and maintain economic stability.<\/p>\r\n                <\/div><\/div><\/section>\n<section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">What is a monetary policy for dummies?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">Imagine the economy on a double-sided scale. On one side is economic growth and employment, while on the other is inflation and price stability. A central bank can use monetary policy to balance each side of the scale when it gets weighed down. When the economic growth side gets too heavy, interest rates can be lowered to lessen this burden. When the inflation side gets too heavy, interest rates can be raised to decrease the money supply and balance the economy this way.<\/p>\r\n                <\/div><\/div><\/section>\n<section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">What are the 4 monetary policies?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">There were 4 main types of monetary policy:<\/p>\n<ul>\n<li>Expansionary monetary policy<\/li>\n<li>Contractionary monetary policy<\/li>\n<li>Quantitative easing (QE)<\/li>\n<li>Quantitative tightening (QT)<\/li>\n<\/ul>\n<\/p>\r\n                <\/div><\/div><\/section>\n<\/div>","protected":false},"excerpt":{"rendered":"<p>What is Monetary Policy? Monetary policy is a series of actions taken by a country&#8217;s central bank to maintain a stable economy and employment with the use of various tools such as interest rates and asset purchasing. Types of Monetary Policy Based on the monetary policy definition, there are two main types of policies: expansionary [&hellip;]<\/p>\n","protected":false},"author":287067,"featured_media":270103,"comment_status":"open","ping_status":"closed","template":"","format":"standard","meta":{"_acf_changed":false,"_lmt_disableupdate":"","_lmt_disable":"","om_disable_all_campaigns":false,"footnotes":""},"definitioncat":[1283],"class_list":["post-270100","definition","type-definition","status-publish","format-standard","has-post-thumbnail","hentry","definitioncat-investing"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v23.8 (Yoast SEO v23.8) - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>What is Monetary Policy? 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