Monetary policy is the actions taken by the central bank of a country to manipulate liquidity, i.e. the amount of money available in the economy. Such actions include modifying the interest rates, bank reserves, etc.
To illustrate, let’s suppose that you have the responsibility of controlling the market of a certain product in a country. In this market, manufacturers have a certain rate of production capacity. Furthermore, you can control and change the amount of money that buyers have and therefore you can affect their purchasing power.
If you aim to empower the market of the country, you must take measures to increase the production. If producers produce more, and buyers buy more, money will flow smoothly in the economy, causing economic growth. More production will need more workforce which may reduce the unemployment. Also, if the manufactured products are of high quality, then they can be exported, which will bring more money into the country and hence, increases the purchasing power even further. These are the positive outcomes of a proper monetary policy.
On the other hand, if you give them too much money, it will cause inflation, since it will enhance the demand side while the supply side has not changed. As the demand increases, the prices will increase too. Therefore, people will have to buy the products more expensively as a result of the inflation. This is the negative outcome of a bad monetary policy.
So, this shows how important it is to implement proper monetary policies. Monetary policies can be divided into two major categories. Contractionary Monetary Policies are those which will lower the liquidity level in the economy, by raising interest rates or selling government bonds through open market operation. Nonetheless, expansionary monetary policies are the exact opposite, which enhance the liquidity level by lowering interest rates or buying securities.
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