What is monetary policy?

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Andrew Goldman

Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew's past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC's Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals" podcast.

Though central banks may have been created with various missions, like creating “maximum employment,” as the United State’s Federal Reserve was tasked with doing when it was created in 1913, the primary lever they have to affect change is through interest rates.

If an economy is sluggish, and inflation isn’t a problem, standard monetary policy would be for the central bank to lower interest rates, that is, decrease the cost of borrowing money for everyone from huge corporations on down to the guy next door who wants Toyota payments he can afford. The fancy term for lowering interest rates is expansionary monetary policy. Conversely, if an economy is operating too well, that is, money is too prevalent and available, inflation will occur, and a currency will become less valuable, creating conditions where in extreme cases, citizens may need to roll a wheelbarrow full of paper currency to the store to buy a bar of soap. Raising interest rates to slow growth is called contractionary monetary policy.

Monetary policy may also include dictating how much banks must keep in reserve to guard against bank runs. Economies that are unable to lower interest rates because of inflation, may try to stimulate an economy using quantitative easing, a process in which a government buys large chunks of its own assets, like bonds, and the cash that it has paid itself will make its way into the country's banks, who will be free to lend it out, stimulating the entire economy.

Last Updated August 1, 2018

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