Monetary Policy Effect on Macroeconomics

Monetary policy effect on Macroeconomics

Monetary policy is the method by which the government, central bank, or monetary authority controls the supply of money, or trading foreign exchange markets. This policy is usually called either an expansionary policy, or a contractionary policy. An expansionary policy multiplies the total supply of money in the economy, and a contractionary policy diminishes the total supply. Expansionary policy is used to tackle unemployment in an economic decline by lowering interest rates, while contractionary policy has the goal of elevating interest rates to fight inflation. Monetary policy reposes on the relationship between the rates of interest in an economy and the total dispense of money.

Monetary policy uses a diversity of tools to dominate exchange rates with other currencies and unemployment. This is done in order to influence outcomes like economic growth and inflation. A policy is called contractionary if it diminishes the size of the money supply or increases the interest rate. An expansionary policy raises the size of the money supply, or lowers the interest rate. Monetary policies are accommodative if the interest rate is intended to stimulate economic growth, neutral if it is intended to neither encourage growth nor fight inflation, or tight if its aim is to reduce inflation.

There are several monetary policy tools available to achieve these results. The Fed has three of these tools. Open market operations, reserve requirements and discount window lending. Open market operations are the most important tool of monetary policy used by the Fed. These operations involve the Fed buying and selling prior issued U.S. government securities. Reserve requirements are the percentages of precise kinds of deposits that banks must keep in their vaults or deposit at a Federal Reserve Bank. Banks and other institutions keep a certain amount of funds in reserve to meet unforeseen outflows. Banks keep these reserves as cash in their vaults or as deposits with the Fed,