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Monetary policy is the process by which the government, central bank, or monetary authority manages the money supply to achieve specific goals?such as constraining inflation or deflation, maintaining an exchange rate, achieving full employment or economic growth. Usually the goal of monetary policy is to accommodate economic growth in an environment of stable prices. Monetary policy can involve changing certain interest rates, either directly or indirectly through open market operations, setting reserve requirements, acting as a last-resort lender, or trading in foreign exchange markets. Monetary theory provides insight into how to craft optimal monetary policy. [1.]
Monetary policy is generally referred to as either being an expansionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy has the goal of raising interest rates to combat inflation (or cool an otherwise overheated economy). Monetary policy should be contrasted with fiscal policy, which refers to government borrowing, spending and taxation. [1.]
There are many macroeconomic factors that the monetary policy effect. One of those factors are inflation. Webster defines inflation as a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services. Wages and prices will begin to rise at faster rates if monetary policy stimulates aggregate demand enough to push labor and capital markets beyond their long-run c ...