Monetary policy controls the money supply, affecting interest rates and economic factors. Views differ on how expansionary monetary policy affects unemployment, income, and output. Tools include regulating bank reserves, altering interest rates, and increasing/decreasing lending. The classical view holds a direct correlation between money supply and price levels, while Keynesian theory suggests an indirect link. Expansionary policy increases the money supply until it exceeds demand, reducing interest rates. Reserve requirements can be reduced to increase lending. Different institutions have varying control over monetary policy.
Monetary policy is a term used to refer to the control of the money supply by a government or by whichever institution has authority over money in a given economic system. In an easy monetary policy, those in control of money try to increase the money supply. Changing the money supply can alter interest rates, price levels and other important economic factors. Different business schools, however, disagree on how expansionary monetary policy affects economic issues such as unemployment, income, and output. There are several different economic tools for changing the money supply, including regulating bank money reserves, altering interest rates, and increasing or decreasing money lending.
There are different views on the effects that expansionary monetary policy has on the economy. The classical view of monetary policy, which is based on a quantity theory of money, holds that there is a direct and strong correlation between the money supply and price levels. Keynesian economic theory, however, supports the idea that there is only an indirect link between the two and that it may not be particularly useful. Thus, Keynesian economists are more likely to use fiscal policy than monetary policy to cause economic change.
Much of monetary policy aims to manipulate the money supply in relation to the demand for money. An expansionary monetary policy, therefore, often involves increasing the money supply until it exceeds demand. Assuming there are no unexpected variables in the economy, this often leads to a generalized reduction in interest rates.
Banks are required to keep a certain amount of money in reserve, which means they cannot lend this money away. This policy aims to ensure that banks always have sufficient funds to handle withdrawals. It also provides a tool for money supply manipulation. In an expansionary monetary policy, the monetary authority can reduce this reserve requirement, thus allowing banks to lend more money. This loose monetary policy introduces more money into the economy, thereby increasing the money supply.
The tools available for expansionary monetary policy vary according to the nature of a given economic system. Different central banks, finance ministries or government departments have different levels of control over monetary policy. In the United States, for example, the Federal Reserve has substantial leverage to implement an expansionary monetary policy. It does this by setting certain interest rates and lending money to other banks in the United States.
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