Monetary Policy

Monetary policy is a set of tools that a nation's central bank has available to promote sustainable economic growth by controlling the overall supply of money that is available to the nation's banks, its consumers, and its businesses.

The goal is to keep the economy humming along at a rate that is neither too hot nor too cold. The central bank may force up interest rates on borrowing in order to discourage spending or force down interest rates to inspire more borrowing and spending.

The main weapon at its disposal is the nation's money. The central bank sets the rates it charges to loan money to the nation's banks. When it raises or lowers its rates, all financial institutions tweak the rates they charge all of their customers, from big businesses borrowing for major projects to home buyers applying for mortgages.

All of those customers are rate-sensitive. They're more likely to borrow when rates are low and put off borrowing when rates are high.

Monetary policy is the control of the quantity of money available in an economy and the channels by which new money is supplied.

By managing the money supply, a central bank aims to influence macroeconomic factors including inflation, the rate of consumption, economic growth, and overall liquidity.

In addition to modifying the interest rate, a central bank may buy or sell government bonds, regulate foreign exchange (forex) rates, and revise the amount of cash that the banks are required to maintain as reserves.

Economists, analysts, and investors eagerly await monetary policy decisions and even the minutes of meetings in which they are discussed. This is news that has a long-lasting impact on the overall economy as well as on specific industry sectors and markets.

Monetary policy is formulated based on inputs from a variety of sources. The monetary authority may look at macroeconomic numbers such as gross domestic product (GDP) and inflation, industry and sector-specific growth rates, and associated figures.

Geopolitical developments are monitored. Oil embargos or the imposition (or lifting) of trade tariffs are examples of actions that can have a far-reaching impact.

The central bank may also consider concerns raised by groups representing specific industries and businesses, survey results from private organizations, and inputs from other government agencies.

Monetary authorities are typically given broad policy mandates to achieve a stable rise in gross domestic product (GDP), keep unemployment low, and maintain foreign exchange (forex) and inflation rates in a predictable range.

The Federal Reserve Bank is in charge of monetary policy in the U.S. The Federal Reserve (Fed) has what is commonly referred to as a dual mandate: to achieve maximum employment while keeping inflation in check.

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