Definition:
Monetary policy refers to a set of policies put in place by authorities to control the money supply and interest rates of a particular nation. The monetary policy is set and controlled by a central bank or currency board.
Understanding the term:
Monetary policies are set to ensure economic stability through controlled interest and inflation rates. These policies can be either contractionary or expansionary. In the case of contractionary policies, a nation’s economy is controlled to keep relatively slow growth rates. For instance, a central bank may impose an increase in interest rates for commercial banks to decrease the amount of money in circulation. This results in either stable or decreased inflation rates. On the other hand, expansionary monetary policy is a macroeconomic strategy intending to stimulate the economy by increasing the money supply. Central banks can reduce short-term interest rates, buy securities, and lower reserve requirements. Expansionary monetary policies usually promote economic growth and decrease unemployment. The policies can also benefit the economy if it includes currency devaluation, which can increase the competitiveness of exports. Many people believe that cryptocurrencies such as Bitcoin can co-exist within the current monetary system, even replacing fiat currencies in the future. However, for cryptocurrencies to conform to monetary policies, they would cease to serve their purpose. One of the biggest features of cryptocurrencies is that they aren’t regulated by a single authority such as a central bank. Monetary policies, thus, cannot be applied to any form of cryptocurrency as they are decentralized.
Takeaways:
Central banks use monetary policies as a tool to control the ebb and flow of money throughout a nation’s economy. They are important as they create booms and busts in an economic cycle.