What is Monetary Policy? Types, Tools & Economic Impact

Last Updated On -08 Oct 2025

Are you wondering what monetary policy is? An effective policy regulating the money supply in a country. This article will guide you through the different types. The article also discusses the common tools used and the economic impact. Let us explore the common tools used in monetary policy to evaluate money supply and credit conditions.

What is Monetary Policy?

The Monetary policy is a process where the central bank of a country controls the money supply, establishes the macroeconomic goals, like sustainable economic growth, full employment, and price stability.

Central Banks across countries use tools of monetary policy like policy interest rates, open market operations, and research requirements to influence the economy.

Types of Monetary Policy

Two specific types of monetary policy facilitate the integration of money and promote sustainable economic growth. Below are the two types and their impact on the economy.

Expansionary monetary policy - it is used to stimulate the economy
Contractionary monetary policy - it is used to reduce inflation

How Does it Work?

It is the policy that is implemented by central banks that influences the economy of the country. It also evaluates the availability of money, policy interest rates, impacts inflation, and economic growth. Below are the different ways in which monetary policy works effectively.

Central Bank Actions

The monetary policy is used by central banks of countries through tools to influence the money supply, credit conditions, and interest rates. Central banks like the European Central Bank, the Federal Reserve, the Reserve Bank of India, and others are primarily responsible for implementing monetary policy. Furthermore, it is their responsibility to stabilize the demand and supply of money in the market.

Interest Rate Influence

The policy rates, like the repo rate, are adjusted through monetary policy. The central bank influences the lending rates of commercial banks, which affects borrowing and spending in the economy. It encourages investment and borrowing, thus making the market more stable for economic activities. When taking loans, institutions and individuals must make effective decisions based on the interest rates.

Impact on Money Behavior

With the monetary policy, there are changes in the interest rates that affect the decision of people to save or invest. Furthermore, it impacts inflation, economic growth, and employment. It matters because it helps in decision-making towards mortgage payments, personal loans, and business investments. With the implementation of monetary policy, the business behaves is dependent on money behavior.

Key Objectives

There are several key objectives when implementing the monetary policy in the economy of a country. Additionally, these elements contribute to the overall functions of money in the commercial and government banks and their policies. Below are the key objectives of monetary policy:

Economic Growth - it promotes a sustainable and healthy rate of economic expansion
Price Stability - it helps in controlling inflation, thus maintaining the purchasing power of money
Exchange Rate Stability - it manages the value of the national currency against foreign currencies
Employment - it fosters an environment that supports employment and job creation

Common Tools

Here are some of the common tools that are used to implement monetary policy, evaluate money control, the behavior of money, and the economy of the country. These tools are used by banks, and the insights developed will help in business finance and decision-making. Below are the common tools that are used to calculate money flow, inflation, and other aspects of money in this economy.

Bank Rate/ Policy Rate

This tool helps in influencing overall lending in the economy. It is the rate at which the central banks lend money to the commercial banks.

Open Market Operations

The tool is an integral part of buying and selling government securities. The demand for money is influenced by the monetary policy in the market. It contributes to increasing and decreasing the money supply in the market, along with affecting the short-term interest rates.

Reserve Requirements

The tool affects the amount of money in the world. Its availability in the lending market thus influences the interest rates in the economy. The commercial banks hold a fraction of deposits in reserve, which contributes to the overall loaning services.

Monetary Policy Influences the Economy

In conclusion, the economic growth of a country is supported by the monetary policy, which is used by central banks. It influences the interest rates, which control the credit availability and the money supply. This article is a guide towards the definition of monetary policy, its types, tools, and how it works.

Frequently Asked Questions (FAQs) on Monetary Policy

Who is responsible for implementing monetary policy?

Monetary policy is formulated and implemented by the central bank in most countries, such as the Federal Reserve in the U.S. or the European Central Bank in the EU.

What is monetary policy in a level economics?

Monetary policy is used to understand, control, and evaluate the money flow in this economy. It integrates a wide range of policies and tools.

What is the budget deficit?

A budget deficit occurs when the total spending of the government exceeds the revenue of the government in a limited period. The economic downturns, decreased tax revenue, and the infrastructure of the economy are influenced by monetary policy.

How many times is monetary policy in a year?

Based on the economic conditions of the country and analysing the inflation, thus releases a monetary policy report every six months. Based on the forecasts, economic assessments, and comprehensive reports, the policy is established effectively.

Who controls monetary policy?

The money supply and credit conditions are regulated with the implementation of monetary policy by the central bank of a country, thus achieving economic goals like price growth and stability.