Monetary Policy
Monetary policy describes the ways in which the central banks change the money supply in order to accomplish certain economic objectives. In the U.S. this is done by the Federal Reserve.
Intro to Monetary Policy
-
Monetary policy is how central banks influence the economy by raising or lowering the money supply. This is in contrast to fiscal policy, which is how the government uses its taxes and spending to affect the economy.
Learn More What Central Banks Do -
Monetary policy has a few main tools—reserve requirements, discount rates, open market operations (OMO), and quantitative easing (QE).
-
Monetary policy affects markets in many ways, however, two main ones include boosting or dampening the economy as a whole, and raising or lowering bond yields. First, as expansionary monetary policy can boost the economy as a whole, investments more sensitive to the business cycle will usually benefit and vice versa with contractionary policy. Secondly, monetary policy’s effect on interest rates causes yields to rise and fall, which changes the relative value of existing interest-bearing investments.
Learn More How Monetary Policy Affects Your Investments -
Expansionary monetary policy is when a central bank increases the money supply which fights recessions and increases economic growth. Contractionary economic policy pulls money out of the economy in order to fight inflation.
Learn More Examples of Expansionary Monetary Policies
Key Terms
- Tapering
Tapering is the process of gradually decreasing the size of an expansionary monetary policy. This can include any form of monetary policy but is most often applied to quantitative easing (QE).
- Foreign Exchange Reserves
Foreign exchange reserves, also called Forex reserves, are stores of foreign currencies held by central banks. The central banks use these to purchase their own currency to carry out monetary policy.
- M2
M2 is one way to measure the money supply. It includes all cash and checking deposits, referred to as M1, as well as savings deposits, money market securities, and certificates of deposit (CD).
- International Monetary Fund (IMF)
The IMF is a multinational organization meant to promote economic growth, ensure the stability of the world financial system, and lower poverty. It offers grants, loans, and other financial assistance to countries to accomplish these goals.
- Liquidity Trap
A liquidity trap is when cash savings rates are high and interest rates are low. This combination makes it difficult for monetary policy to affect the economy.
- Economic Stimulus
Economic stimulus refers to policies undertaken by a government or central bank to increase economic growth and counter recession. These can be either fiscal or monetary in nature.
- Currency
A currency is anything that serves as a medium of exchange, a store of value, and a unit of account. Most countries have a standard currency to serve these functions in that country.
- Trilemma
The monetary policy trilemma is the inability to simultaneously have a fixed currency exchange rate, allow capital to flow in and out of a country freely, and maintain an autonomous monetary policy. A country can only have two of the above and the decision as to which two is a critical part of monetary policy.
![Swiss National Bank building view.](https://www.investopedia.com/thmb/4l-kYQ-H2OFtH51dAOP_yrXh84U=/7408x4892/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-1248367302-fc882235a244481bb98e30f6e0cfe0e5.jpg)
![U.S. delegates at the Bretton Woods Conference in Bretton Woods, N.H., with Assistant Secretary of the Treasury Harry Dexter White standing far left.](https://www.investopedia.com/thmb/LOPyCnDZWfV-vGS5KJbpxzN2k00=/4216x3168/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-515422984-57b34c093df78cd39c67a323.jpg)
![Quantitative Tightening (QT): Removing money from financial markets to stem the dangers posed by an overheating economy.](https://www.investopedia.com/thmb/QMUOgSrvauzHvTkcyahArrP8V-U=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/Quantitative-tightening-6361478_final-a184a253c81d408cb2d495236098555f.png)
![The First Bank of the United States](https://www.investopedia.com/thmb/afykPuJZHlfLHofDLCMV22Zer1Y=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/first-bank-united-states-5217537-final-ad01e349ae7647e5b2f6448219abd66d.png)
![Paycheck Protection Program Liquidity Facility (PPPLF)](https://www.investopedia.com/thmb/d4_qnTqtDa4pbGSS_92-SMvjsqM=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/paycheck-protection-program-liquidity-facility-ppplf-4802298-Final-b9b629ba649d41c1b30d7eface2b6f16.jpg)
Explore Monetary Policy
![Money Market Mutual Fund Liquidity Facility](https://www.investopedia.com/thmb/CGmXySYPpcao1R0FdQgASdJyAcQ=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/money-market-mutual-fund-liquidity-facility.asp-final-4468e0c7ba9a4dcd8952553fb88b08d2.png)
![Building Wealth](https://www.investopedia.com/thmb/5oXdVkacYTfZrTywNm-OwFQaPu0=/3867x2578/filters:no_upscale():max_bytes(150000):strip_icc()/BuildingWealthandSavingMoney-56d2ae655f9b5879cc888593.jpg)
![](https://www.investopedia.com/thmb/Ju5UP9dB36rss7iO_vqOVo-Jc0w=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/semiconductors_shutterstock_263178281-5bfc314fc9e77c0058781a11.jpg)
![](https://www.investopedia.com/thmb/tuWlN2Y8scne8FOKJNZwslhUfOw=/380x253/filters:no_upscale():max_bytes(150000):strip_icc()/145238812-5bfc2b9446e0fb005144dd0b.jpg)
![International Monetary Fund (IMF)](https://www.investopedia.com/thmb/eU9sjgVtSpHxhL3j8xLZnA8yY40=/1500x1000/filters:no_upscale():max_bytes(150000):strip_icc()/International-Monetary-Fund-341cc9af70f348608e6f58b636ab995b.jpg)
![M2](https://www.investopedia.com/thmb/NWCoDvM6E0vaNX7VXpbUz5QmwRY=/1500x1000/filters:no_upscale():max_bytes(150000):strip_icc()/m2-Final-2df63feeb3174bafaf1eb8818803c4f7.jpg)
![Demonetization: Removing the legal tender status of a currency.](https://www.investopedia.com/thmb/dOEUYcCYu_tAp800Tc2sYnPd1nM=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/demonetization.asp-Final-a9db42f5efeb4591a909d14ced844dcd.jpg)
![Import Substitution Industrialization (ISI): An economic policy sometimes adopted by developing nations to decrease their dependence on developed countries.](https://www.investopedia.com/thmb/iaaiIwQ0ezw4KMLMuzaPpyce9Xs=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/Importsubstitutionindustrialization_fina-6e602d6aeb31439b996af6b00418c418.png)
![Fixed Exchange Rate: Tying the value of a countryâs currency to another currency or the price of gold.](https://www.investopedia.com/thmb/NuixPRzJ4Vsv76OcMXWsD0_SXus=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/fixedexchangerate.asp-final-011fb780c9e94f12930ab6bc68e9c607.png)
![](https://www.investopedia.com/thmb/98L6os_dGUdWGh1UcX5nXkA40Jo=/205x136/filters:no_upscale():max_bytes(150000):strip_icc()/investing13-5bfc2b8f46e0fb0026016f4d.jpg)
![](https://www.investopedia.com/thmb/81ghgh0axGPO2KOXMCAxf4WZFmQ=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/investing3-5bfc2b8e46e0fb0026016f32.jpg)
![Person trying to make a decision in front of a computer](https://www.investopedia.com/thmb/p3Mmg9AMF8Xchm5SEEmu11CH6WQ=/8256x5504/filters:no_upscale():max_bytes(150000):strip_icc()/WhatIsaTrilemma-0849335848fe4388a3d6672b51a77d59.jpg)
![Group of Seven (G7): An intergovernmental organization made up of the world's largest developed economies that meets periodically to address international economic and monetary issues.](https://www.investopedia.com/thmb/aYnFe0KSxuipAs6M0YJFI6K6vnU=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/G7_final-2883cac3bc9643ae8c3adbbe05c205c1.png)
![Marriner S. Eccles Federal Reserve Board Building](https://www.investopedia.com/thmb/i0YOGh9iBuV6hLUBIuOnziqXKSI=/2118x1415/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-678685052-53eaabda036a4f0cac7a7dd8b19ce000.jpg)
![](https://www.investopedia.com/thmb/TR5JKL2J4nCVfzaq0_ZVY_ViLc4=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/money-5bfc36f646e0fb0026042c87.jpg)
![The Federal Reserve building in Washington.](https://www.investopedia.com/thmb/-sU6cg4AOX3pQCt5VeT0vjDqTmI=/5120x3413/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-520138826-9004669b6db04a4e94194fedee04294a.jpg)
![Aerial view of midtown Manhattan at night](https://www.investopedia.com/thmb/1I1IKMfRkeJzY5aMjI8aLi5shQ4=/2119x1414/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-947951936-2b8515aecba94cfcb194eee155918c7f.jpg)
![](https://www.investopedia.com/thmb/2IVGelJ8UhbOw8Srqpo8-6JjDSA=/205x136/filters:no_upscale():max_bytes(150000):strip_icc()/98396151-5bfc2dc846e0fb0051453f8e.jpg)
![Charts of the unemployment rate](https://www.investopedia.com/thmb/kNe7ewsyrAOuAeS0zwKUz85XZaE=/3504x2336/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-172752359-82d9bd91a55f492e9bb9cd35c5e71358.jpg)
![Econ](https://www.investopedia.com/thmb/ZZfZpatU3oTdGpRKc4Q6I0zWMJ8=/980x503/filters:no_upscale():max_bytes(150000):strip_icc()/Economics-e22b6594e7f44dada4597c6b1ee0a2a4.jpg)
![Liquidity Trap](https://www.investopedia.com/thmb/Qb-idmQQjDGWiTnt_YVrAWFYhvA=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/liquiditytrap.asp_Final-6590b33aa8b54861871f159ddcbf8aac.png)
![](https://www.investopedia.com/thmb/WD7DPrQHUkyc5ShhXpfd_-SA5vc=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/wall_street_179681980-5bfc2b9746e0fb0083c07d29.jpg)
![](https://www.investopedia.com/thmb/zPkUnNFc4xwyuFEl4_SRK172Bhg=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/shutterstock_67023106-5bfc2b54c9e77c0026b4eee9.jpg)
![A pile of Canadian money](https://www.investopedia.com/thmb/swm0rYtvUEXMGmlzE46RZ1cNo-w=/2121x1414/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-185066026-1b8a401f7b3446beb6714073a912cbf4.jpg)
![Federal Reserve Building in Washington D.C.](https://www.investopedia.com/thmb/IU9e6RnvC4PMV-2R7k4AOgBgk6s=/2121x1414/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-520138826-72520152f6a74317b0b634ddeac6c59c.jpg)
![](https://www.investopedia.com/thmb/UaAlLr7ZsTdzHHq11QKh5X9iqL0=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/shutterstock_253136563-5bfc2b98c9e77c00519aa7a8.jpg)
![federal reserve building](https://www.investopedia.com/thmb/sCJy6z1ClDWMYk8tJFZv4Yk2Pl8=/5491x3649/filters:no_upscale():max_bytes(150000):strip_icc()/washington-d-c--main-sights-and-city-details-851057382-9d6f22c3463946f780167e703f18ce9b.jpg)
![Full Frame Shot of Paper Currencies on Table](https://www.investopedia.com/thmb/VgZIF8Lr8VoR-cICKPzUHHAdqzo=/1500x1003/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-1054017850-94cc2cd2d3dc46f8870987d17ae4e279.jpg)
![Foreign Exchange Reserves](https://www.investopedia.com/thmb/T7TbmDedgz7UFxC4I7p_QjLDLTg=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/foreign-exchange-reserves.asp-final-903ad3568b0049d49a0ef043d39149e1.jpg)
![](https://www.investopedia.com/thmb/Awc9c9x14kt4SfIfHwMCiOsftuk=/1756x1082/filters:no_upscale():max_bytes(150000):strip_icc()/adobestock_226017825_editorial_use_only-5bfc2e61c9e77c00518051fc.jpeg)
![Monetary Base: The total amount of a currency in circulation or held in reserves.](https://www.investopedia.com/thmb/CGx7TVsxhk802KP5fufQxPkTyQg=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/Monetarybase_final-e058b463445843cc917af5a16659972c.png)
![](https://www.investopedia.com/thmb/GdDUYXMSvxzEMPSua9MTEL08AjI=/205x136/filters:no_upscale():max_bytes(150000):strip_icc()/investing20-5bfc2b8f46e0fb00517be081.jpg)
![](https://www.investopedia.com/thmb/TzggaeUk85a8Bpa7X8YX44QcWFA=/205x136/filters:no_upscale():max_bytes(150000):strip_icc()/investing14-5bfc2b8f46e0fb00265beb22.jpg)
![Mumbai Interbank Bid Rate (MIBID)](https://www.investopedia.com/thmb/T1jTjMnf6e4IKahqhRL0njQx5h0=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/mibid.asp-final-1aded9fc94504222a1a4935772912769.png)
![Street in City of London with Royal Exchange, Bank of England and new modern skyscrapers, England, UK](https://www.investopedia.com/thmb/NyMj7EFJPctKBz1e-3p_jgku8_g=/2121x1414/filters:no_upscale():max_bytes(150000):strip_icc()/street-in-city-of-london-with-royal-exchange--bank-of-england-and-new-modern-skyscrapers--england--uk-923317900-cc8daffff0da44d38a6aacd70b8204cf.jpg)
![Federal Reserve bank](https://www.investopedia.com/thmb/HTHkYBc9q85J8IsNgLWk7zcEzIw=/2130x1408/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-97765256-959b9250a4c94deb86da2293c07ad025.jpg)
![Common Equity Tier 1 (CET1)](https://www.investopedia.com/thmb/lXC6YG61j_NA3X2oimA_eFJEUcs=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/Common-equity-tier-1-cet1_final-cb6afdb761574a8f867c846f81bc5de4.png)
![](https://www.investopedia.com/thmb/355jifkvqlwZpglYKoMrWYQZrJI=/680x510/filters:no_upscale():max_bytes(150000):strip_icc()/shutterstock_325626635_bank_of_japan-5bfc3b9b46e0fb0051801a4e.jpg)
![A group of doll figures standing around a money puzzle piece indicating a Central Bank's monetary policy.](https://www.investopedia.com/thmb/TMPkCylq18I2LyrTRUsH-S5M8_g=/2121x1414/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-112230138-159022cca5e841239eac61ffc0b2f125.jpg)
![](https://www.investopedia.com/thmb/YZA8k0K-3hndcAqYIIaBEjhwJiU=/205x136/filters:no_upscale():max_bytes(150000):strip_icc()/forex10-5bfc2b9346e0fb00260b24d9.jpg)
![](https://www.investopedia.com/thmb/zciVmLJoaHqpAdMhBfjPCWBLicU=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/155258776-5bfc2b5446e0fb005119a7d7.jpg)
![](https://www.investopedia.com/thmb/f5knozohAfvRWfysIstBnljuvn4=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/investing5-5bfc2b8e46e0fb0026016f0e.jpg)
![United States Federal Reserve Building, Washington DC, USA](https://www.investopedia.com/thmb/OltVXZxMHlxFbEx1IczzoRMMzvA=/2119x1415/filters:no_upscale():max_bytes(150000):strip_icc()/united-states-federal-reserve-building--washington-dc--usa-699686820-c2df5c2c75064ef5a58d2703999aaca1.jpg)
![](https://www.investopedia.com/thmb/bkAwzURRhujHVe98jxgRNH5vtGQ=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/investing2-5bfc2b8fc9e77c005143f176.jpg)
![](https://www.investopedia.com/thmb/xOq7JYOmS3VteuUR6W1DtsrUPzY=/205x136/filters:no_upscale():max_bytes(150000):strip_icc()/investing10-5bfc2b90c9e77c00517fd2ef.jpg)
![Indian Rupees](https://www.investopedia.com/thmb/OUS3w8KkSCJzuVB14SopWSkV4DA=/2048x1536/filters:no_upscale():max_bytes(150000):strip_icc()/32190943222_d2f38af525_k-a26a5d1ea4b84606a0291832861cd61d.jpg)
![CENTRAL BANK OF IRELAND NEW HEADQUARTERS [NORTH WALL QUAY]-1324671](https://www.investopedia.com/thmb/W6ecUASDqm9Fx98s-X9k4buSRsI=/2048x1366/filters:no_upscale():max_bytes(150000):strip_icc()/36960441942_933c962a43_k-7bef3f0503ae4eb4ade5b9e86f9a5e58.jpg)
![Federal Reserve Building](https://www.investopedia.com/thmb/NXdZSzQiyT5b-Uq37Vn0s5Mjhyg=/2048x1536/filters:no_upscale():max_bytes(150000):strip_icc()/federal-reserve-building-144366870-9b8bc08634d148eb8ae3a5283618e098.jpg)
![Macroeconomic Stabilization Fund (FEM)](https://www.investopedia.com/thmb/u6BomSeoR8fivpfZxQd4kFCwvtU=/1500x1000/filters:no_upscale():max_bytes(150000):strip_icc()/macroeconomic-stabilization-fund-fem.asp_final-e420eec752594fc4aa2b9c785bdae559.png)
![Stock Analysis](https://www.investopedia.com/thmb/EsRrfoqcEIHgSNuuyLQiJg-KkI4=/1500x1000/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-1025886228-bccfb42fca614ec4a8ee90cd886fe561.jpg)
![Building with columns](https://www.investopedia.com/thmb/voTDveJnZKWvrh2csOfBRI6dONY=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/investing8-5bfc2b8d46e0fb005144dbe3.jpg)
![People discussing policy](https://www.investopedia.com/thmb/Spntcm-61VInErOQJmvaINc1xXg=/5128x3412/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-169259776-f3cb3b5f70664f64aeeda580586b4467.jpg)
![Close up of the Capitol Building, Capitol Hill, Washington, D.C., United States of America, North America](https://www.investopedia.com/thmb/-1fv85AH7t4N5ibgAYXlSN4uc70=/5200x3454/filters:no_upscale():max_bytes(150000):strip_icc()/close-up-of-the-capitol-building--capitol-hill--washington--d-c---united-states-of-america--north-america-479698089-59b5f5ec396e5a0010e24e47.jpg)
![Currencies](https://www.investopedia.com/thmb/HyKK67ij5RofyJ4hjkoW2s-OTIo=/1500x1000/filters:no_upscale():max_bytes(150000):strip_icc()/mixed-money-56a0a06d5f9b58eba4b23ccf.jpg)
![yuan1.jpg](https://www.investopedia.com/thmb/-NDqpg_4VXBVbCqw2frhst6tTRg=/2048x1536/filters:no_upscale():max_bytes(150000):strip_icc()/yuan1-56a31b765f9b58b7d0d0627e.jpg)
![Currency](https://www.investopedia.com/thmb/vdxeyzlvZne1fPUuDjFamVyGyu8=/4000x2700/filters:no_upscale():max_bytes(150000):strip_icc()/currency.asp-final-511435b7c30b4e7ab00cce310c69543d.png)
![](https://www.investopedia.com/thmb/LhnsGBFR6E4BTaS7IZmt-CS7fg8=/205x136/filters:no_upscale():max_bytes(150000):strip_icc()/investing19-5bfc2b8f4cedfd0026c1194c.jpg)
![Stimulus Check](https://www.investopedia.com/thmb/JmfsVGYC6D2MMMc7UP4_MunVG2M=/1500x1000/filters:no_upscale():max_bytes(150000):strip_icc()/Investopedia_StimulusCheck-70459e6dcc644ec28a518b746239f62f.jpg)
![](https://www.investopedia.com/thmb/-zhhJkjtdWtM7LtIDUo_mY1vSq8=/680x440/filters:no_upscale():max_bytes(150000):strip_icc()/thinkstockphotos_80410231-5bfc2b97c9e77c0026b4fb20.jpg)
![Estate Agent Gives Pen and Documents Agreement With Customer To](https://www.investopedia.com/thmb/_BnrBg7QWjasxUw4c_9fAN1J2J4=/1500x1000/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-875093682-81effe80bc4f49e580d9e2b375addba3.jpg)