What is Monetary Policy? What are its importance and impacts?

What is Monetary Policy?

Monetary policy is a set of economic policy that manages the size and growth rate of the money supply in an economy. It is a powerful tool to regulate macroeconomic variables such as inflation and unemployment.

Monetary policies are implemented through different tools, including the adjustment of the interest
rates, purchase or sale of government securities, and changing the amount of cash circulating in the economy. The central bank or a similar regulatory organization is responsible for formulating monetary policies.

Importance of Monetary Policy:

To ensure economic stability at full-employment or potential level of output;
To achieve price stability by controlling inflation and deflation; and
To promote and encourage economic growth in the economy.

Monetary policy is concerned with changing the supply of money stock and rate of interest for the purpose of stabilising the economy at full-employment or potential output level by influencing the level of aggregate demand.

More specifically, at times of recession monetary policy involves the adoption of some monetary tools which tend the increase the money supply and lower interest rates so as to stimulate aggregate demand in the economy, on the other hand, at times of inflation, monetary policy seeks to contract the aggregate spending by tightening the money supply or raising the rate of interest. Monetary policy has also to promote and encourage economic growth both in the industrial and agricultural sectors of the economy.

Impacts of Monetary Policy:

Monetary policy is a powerful tool that the government and concerned monetary authorities use to influence the economy based on a reaction to certain issues and predictions of where the economy is moving. The monetary authorities need to make accurate predictions based on solid information to properly adjust the money flow and rates of interest. There is an inverse relationship in money flow and interest rates. Increasing money flow and decreasing interest rates can encourage spending and, as a result, stimulates the economy. More spending means more jobs and curbing unemployment.

Monetary policies have an impact on an individual’s life too. If a government thinks the economy is overheating and growing very fast, there are chances of inflation so, the government may decrease spending.

Similarly, taxes play a vital role in monetary policy. Decreasing taxes can stimulate the economy as people will have more money in pockets to either invest or save. The investments will increase production and more people will be hired reducing the level of unemployment.