What is Monetary Policy

Monetary policy is the process by which central bank of the country controls the money supply in the economy of the country through banking system. Monetary policy can be either an expansionary policy which leads to increase in the money supply in the economy while contractionary policy leads to decrease in the total money supply in the economy.

Monetary policy is primarily used by the central banks to maintain a balance between inflation and growth of the country. So if a country is facing high inflation and high growth then the central bank of a country will follow contractionary policy where it will try to decrease the supply of money in the economy by selling government bonds or treasury bills of government. Another way in which it can be done is to increase the interest rate at which one can make fixed deposit which will lead to people making more deposits in the banks and which in turn will reduce the money supply in the economy. Since banks have to pay higher interest on deposits they will in turn increase the interest rate on loans which will lead to slowdown in demand for loan and ultimately result in contraction in the growth, which is why it is important that central bank maintain the balance between growth and inflation rate while going for contractionary monetary policy.

In case of central bank following expansionary policy, it buys government bonds and treasury from the market thereby increasing the money supply in the economy and also central bank decreases the interest rate on fixed deposit and loans.

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