Monetary Policy 

Money Supply consists of all the money in an economy at one time. 

Includes notes, coins, and current accounts in commercial banks. It concentrates primarily on the money that is used as a medium of exchange. THIS IS NARROW MEASURE

BROAD MEASURE ALSO INCLUDES BANK DEPOSITS AS WELL. 

What is monetary policy?

• Monetary policy covers decisions on the money supply, rate of interest, and the exchange rate.
• Monetary policy influences the supply and/or price of money. 
• The central bank carries out monetary policy measures in many countries.

How does the central bank change the money supply?

Can increase the money supply by 

• printing more money,
• buying back government bonds or 
• encouraging commercial banks to lend more.

Interest Rate

• When the central bank changes interest rates it charges commercial banks, these banks are likely to change the rate of interest to the customers. 
• An increase in interest rates will increase the total interest paid by households and will have less money to spend. 
• An increase in interest rates will discourage households from borrowing large sums, hence decreasing expenditure. 
• Lastly, an increase in interest rates will encourage saving, households will earn more income from saving.

Foreign Exchange Rates

The government may instruct its central bank to change the country’s foreign exchange rate or to try to influence it to move in a particular direction.

The government may want the price of the exchange rate to fall, for example, to encourage a rise in exports. 

Expansionary monetary policy 

This involves a ‘loosening’ of monetary policy by cutting interest rates and/or expanding the money supply. 

Contractionary monetary policy 

This involves raising interest rates and/or cutting the money supply to reduce total demand if the economy is overheating and inflationary pressures are rising.