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What is Monetary Policy?

A Monetary Policy is one of the tools of a Central Bank. It is used to control the overall money supply within a country and promote sustainable economic growth. Monetary Policy strategies include changing the level of interest rates and bank reserve requirements.

There are two types of Monetary Policies: Expansionary and Contractionary.

An Expansionary Monetary Policy is when the Central Bank lowers interest rates. The aim is to encourage households and corporations to borrow and spend more money with the objective of expanding a stagnant economy. Alternatively, the Central Bank may also decide to buy government bonds from the open market, ultimately increasing the money supply. On the other hand, there could also be an ease on bank reserve requirements, enabling banks to originate more loans, and therefore creating money.

A Contractionary Monetary Policy is when the Central Bank increases interest rates. The aim is to slow down economic growth and reduce inflation, as people are less inclined to borrow money as interest rates are high. This is what is happening right now. Another possibility is to sell government bonds to the open market, tightening the money supply. Lastly, the Central Bank may also increase bank reserve requirements, were banks are less able to issue loans.

The typical goals of Monetary Policy include to control inflation and minimise unemployment.

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