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What is Monetary Policy?

Monetary policy is the stance of the central bank at any given time regarding the tightening or loosening of rates, or the issuance of new currency denominations, that will affect the money supply in the country.

Monetary policy is the prerogative of the central bank but may be influenced by congress as well as private banking institutions and the central banks of other countries. The goal of monetary policy is to keep the Federal Funds Rate or the LIBOR, or whatever it might be depending on the country, at just the right level to keep the economy going in the direction that will be most helpful.

The Funds Rate directly affects the Prime Rate, and so raising the funds rate will slow down the economy, or the velocity of money, by making it a little more expensive to get a loan, for banks and their clients. Lowering the rates is termed “loosening” monetary policy and increasing the liquidity of banks and their constituents.

A central bank could also decide to increase or decrease the rate at which currency is printed. Obviously a lot hinges on what the monetary policy is, and the markets experience spikes around Fed announcements. The central bank of the United States is an independent entity and is not part of the federal government; this varies from country to country.

Keywords: monetary policy, interbank loans, federal funds rate, prime rate, velocity of money, banking institutions, central banks, tight and loose monetary policy, money supply,