Monetary policy refers to the use of interest rates, money supply, and other tools by a central bank to control inflation, stabilize the economy, and promote growth. It involves influencing the availability and cost of money in the economy to achieve desired macroeconomic objectives. Central banks adjust policy interest rates, conduct open market operations, and use reserve requirements to manage money supply and influence borrowing costs. The objectives of monetary policy typically include price stability, full employment, and sustainable economic growth.
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Monetary policy is the policy adopted by the monetary authority of a nation to affect monetary and other financial conditions to accomplish broader objectives like high employment and price stability (normally interpreted as a low and stable rate of inflation). Further purposes of a monetary policy may be to contribute to economic stability or to maintain predictable exchange rates with other currencies. Today most central banks in developed countries conduct their monetary policy within an inflation targeting framework, whereas the monetary policies of most developing countries' central banks target some kind of a fixed exchange rate system. A third monetary policy strategy, targeting the money supply, was widely followed during the 1980s, but has diminished in popularity since that, though it is still the official strategy in a number of emerging economies.
The tools of monetary policy vary from central bank to central bank, depending on the country's stage of development, institutional structure, tradition and political system. Interest rate targeting is generally the primary tool, being obtained either directly via administratively changing the central bank's own interest rates or indirectly via open market operations. Interest rates affect general economic activity and consequently employment and inflation via a number of different channels, known collectively as the monetary transmission mechanism, and are also an important determinant of the exchange rate. Other policy tools include communication strategies like forward guidance and in some countries the setting of reserve requirements. Monetary policy is often referred to as being either expansionary (stimulating economic activity and consequently employment and inflation) or contractionary (dampening economic activity, hence decreasing employment and inflation).
Monetary policy affects the economy through financial channels like interest rates, exchange rates and prices of financial assets. This is in contrast to fiscal policy, which relies on changes in taxation and government spending as methods for a government to manage business cycle phenomena such as recessions. In developed countries, monetary policy is generally formed separately from fiscal policy, modern central banks in developed economies being independent of direct government control and directives.
How best to conduct monetary policy is an active and debated research area, drawing on fields like monetary economics as well as other subfields within macroeconomics.