Monetary Policy


refers to the decisions of the Central Bank, CurrencyBoard or other relevant regulatory bodies, which affect the supply ofmoney through interest rates. The governing authorities control thesupply of money by altering the lending interest rates of banks andother financial institutions, buying and selling governmentsecurities, and determining the amount of money that banks shouldmaintain in the vault (Gali, 2015). Using the aforementionedstrategies, the Central Bank can regulate the economy when it isgoing downhill or use them to boost it when it is experiencing asteep climb.

The instruments of are three- open market operations,discount rates, and reserve requirements. Open market operationsinvolve the buying of government securities on a competitive basis.The Central Bank can decide to trade with anyone in the open market.The discount rate refers to the interest that the Central bankcharges on financial institutions on short-term loans (Lippi et al,2013). The reserve requirement refers to the amount of money thatfinancial institutions should make to the Vaults in their custody orwith the Federal Reserve. The deposits function as security and amonetary policy tool.

An expansionary monetary policy seeks to increase the amount of moneyin the economy through purchasing government treasuries, loweringlending rates and decreasing the Federal Reserve requirement. TheExpansionary monetary policy leads to lower interest rates, increasedcredit availability, and influencing business decisions to expand(Jimenez et al, 2014). Contractionary monetary policies on the otherhand lead to higher interests and low availability of credit becauseof low open market activities, low discount rates, and high federalreserves for banks. The policy has a negative impact on businessdecisions because most businesses run on credit.


Galí, J. (2015). Monetary policy, inflation, and the businesscycle: an introduction to the new Keynesian framework and itsapplications. Princeton University Press.

Jiménez, G., Ongena, S., Peydró, J. L., &amp Saurina, J. (2014).Hazardous Times for : What Do Twenty‐ThreeMillion Bank Loans Say About the Effects of on CreditRisk‐Taking?. Econometrica,82(2), 463-505.

Lippi, F., Ragni, S., &amp Trachter, N. (2013). State dependentmonetary policy.