Guide to Monetary Policy

Monetary policy describes the ways in which the central banks change the money supply in order to accomplish certain economic objectives. In the U.S. this is done by the Federal Reserve.

Frequently Asked Questions
  • What is monetary policy?

    Monetary policy is how central banks influence the economy by raising or lowering the money supply. This is in contrast to fiscal policy, which is how the government uses its taxes and spending to affect the economy.

  • What are the tools of monetary policy?

    Monetary policy has a few main tools—reserve requirements, discount rates, open market operations (OMO), and quantitative easing (QE).

  • How does monetary policy affect markets?

    Monetary policy affects markets in many ways, however, two main ones include boosting or dampening the economy as a whole, and raising or lowering bond yields. First, as expansionary monetary policy can boost the economy as a whole, investments more sensitive to the business cycle will usually benefit and vice versa with contractionary policy. Secondly, monetary policy’s effect on interest rates causes yields to rise and fall, which changes the relative value of existing interest-bearing investments.

  • What is the difference between expansionary monetary policy and contractionary monetary policy?

    Expansionary monetary policy is when a central bank increases the money supply which fights recessions and increases economic growth. Contractionary economic policy pulls money out of the economy in order to fight inflation.

Key Terms

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