Monetary Policy Defined
- Monetary policy involves adjusting the money supply so as to influence total (aggregate) demand
- The money supply is the amount of money in an economy at any given moment in time
- It consists of coins, banknotes, bank deposits & central bank reserves
- The Central Bank in each economy is responsible for setting monetary policy
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- The Bank's Monetary Policy Committee usually meets 4-8 times a year to set policy
- The Bank's Monetary Policy Committee usually meets 4-8 times a year to set policy
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The Three Main Instruments of Monetary Policy
- Interest Rates: Incremental adjustments to the interest rate (usually not more than 0.25%)
- Quantitative easing (QE): Increases the supply of money in the economy. The Central Bank creates new money & uses it to buy open-market assets such as bonds. When they buy the bond back early, there is an injection of new money into the economy (investors get their money back & can now spend it)
- Exchange Rates: Adjustments to the exchange rate. The Central Bank is able to influence the exchange rate through buying or selling its own currency. This in turn influences the level of exports/imports
- Monetary policy can be expansionary in order to generate further economic growth (also referred to as loose monetary policy)
- Expansionary policies include reducing interest rates, increasing QE, or depreciating the exchange rate
- Expansionary policies include reducing interest rates, increasing QE, or depreciating the exchange rate
- Monetary policy can be contractionary in order to slow down economic growth or reduce inflation (also referred to as tight monetary policy)
- Contractionary policies include increasing interest rates, decreasing/stopping QE, or appreciating the exchange rate