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Monetary policy, tools, and issues

Read the most recent report by the Federal Reserve Chairman.

* What is monetary policy
* Tools of monetary policy
* Issues in evaluation of monetary policy

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A guide to Monetary policy

What is monetary policy?

Monetary policy is a tool used by the central bank to manage money supply in the economy in order to achieve a desirable growth. The central bank controls the money supply by increasing and decreasing the cost of money, the rate of interest.

Anand Rawani, Economic Times, "What is Monetary Policy?",, accessed 7-1-2011.

Monetary Policy involves changes in the base rate of interest to influence the rate of growth of aggregate demand, the money supply and ultimately price inflation.

Monetarist economists believe that monetary policy is a more powerful weapon than fiscal policy in controlling inflation. Monetary policy also involves changes in the value of the exchange rate since fluctuations in the currency also impact on macroeconomic activity (incomes, output and prices)
Changes in short term interest rates affect the spending and savings behaviour of households and businesses over time and therefore feed through the circular flow of income and spending. The transmission mechanism of monetary policy works with variable time lags depending on the interest elasticity of demand for different goods and services - e.g. the demand for interest-sensitive consumer goods and services bought on credit or the demand for capital investment from private sector businesses. Because of the time lags involved in setting an appropriate level of short-term interest rates, the Bank of England sets nominal interest rates on the basis of hitting the inflation target over a two year forecasting horizon.

Tutor2U, "What is Monetary Policy?",, accessed 7/1/2011.

Tools of monetary policy

There are various tools of monetary policies: Expansionary and Contractionary

Generally speaking contractionary monetary policies and expansionary monetary policies involve changing the level of the money supply in a ...

Solution Summary

This solution describes monetary policy, its tools, and evaluation issues as told by the Federal Reserve Chairman.