What is “Monetary Policy?

The process by which central/ state bank (monetary authority) of a country controls the supply of
money, often targeting the rate of interest and purpose of policy are to promote economic
growth.

Goals of policy

 To promote maximum employment

 Stable prices / price stability
 Moderate long-term interest rates or Interest rate stability
 To achieve economic growth
 Stability of financial
 Stability of foreign exchange market

Types of monetary policy

1. Expansionary monetary policy: Purpose of central bank here to increase the money
supply in economy, and interest rate decreases
2. Contractionary monetary policy: In contraction, the central’s bank purpose is to control
money supply, so the interest rate increases

Tools / Instruments of Monetary policy

1. Open market operations (OMO)

OMO includes the purchase and sale of securities, when central bank applies expansionary
monetary policy and wants to increase the money supply in country then through open market
operations, purchase securities (Bonds) from public and give them money in response, which is
equal to monetary value of that bond. And vice versa is true for contractionary monetary policy.

2. Reserve requirements
Central bank not supplies the whole money in economy, some part of money is held as
reserves in bank. It can be any amount e.g 10% of total money supply. In case of
expansionary policy central bank decrease its reserves level to increase the money
supply in country. For example initially we take 10% as reserves now bank will held 7 to
8% as reserves and supply other part. Opposite is true for contraction.

3. Discount rate
The rate at which central bank gives loan to depositary institutions (commercial banks).
To increase money supply interest rate decreases and to control money supply discount
rate is increases.
How changes monetary policy affect the Economy?

The point of implementing policy through raising or lowering interest rates is to affect people's

and firms' demand for goods and services. This section discusses how policy actions affect real
interest rates, which in turn affect demand and ultimately output, employment, and inflation

How the monetary policy can be used to Control Inflation?

One popular method of controlling inflation is through contractionary monetary policy. The goal

of a contractionary policy is to reduce the money supply within an economy by decreasing bond
prices and increasing interest rates.