Monetary Policy

Define monetary policy, and discuss the recent (20011/2012) direction of monetary policy in a country of your choice.

Monetary policy is the process of controlling the supply of money by the monetary authority, often the central bank of the country, normally targeting the rate of interest to maintain or promote economic growth and stability. Monetary policy uses various tools, to control the price which money is borrowed and the total supply of money. The ability to control the price and the total supply can influence economic growth, inflation, unemployment and exchange rate of currency.

In general, monetary policy has three characteristics. First of all, monetary policy is used to sustain the balance of the total supply and demand by regulating the money supply. In a modern economy, the demand is always expressed as the demand for currency. The needs are linked directly with the money supply. Thus, increase or decrease in the total money supply will expand or contract the needs to achieve balanced economic growth.

Second, monetary policy is the most efficient way to control inflation by regulating interest rates and monetary aggregates to keep a constant price level. Inflation has become a frequent phenomenon in the economics of every country. The ability of controlling inflation has become a main focus point. Although inflation is caused by many reasons, inflation, happens when the amount of money in circulation is more than the amount of goods and labour that the society can provide. Central banks would then control the money supply through implementing monetary policy, and also raising interest rates to encourage savings, reducing the immediate needs and the demand for bank loans as well.

Third, monetary policy can be used to adjust the proportion of national income between consumption and savings. It can affect people's tendency for consumption and savings through the regulation of interest rates.

Crafting optimal monetary policy can be done using Monetary Theory, referred as expansionary or contractionary policy. Expansionary policy has the ability to increase the money supply available in the economy whereas Contractionary policy increases the money supply in a slower pace, or in some cases, reduce the money supply.

Most government uses expansionary policies in hope to stimulate growth by lowering the interest rate, allowing business the opportunities to expand and ease unemployment in the country. Contractionary policies are implemented to slow inflation in mind, in order to avoid distortion and deterioration of asset value.

Several tools are available to achieve these goals, by increasing interest rate by fiat, increasing reserve requirement and reducing the monetary base. These tools are able to increase and also decrease the money supply when used in different situation.

The primary tool of the policy is