Monetary Policy - the process of managing the money supply

Monetary Policy refers to the process of managing a nation's money supply in order to satisfy specific goals such as tightening inflation, achieving full employment or more well-being. The policy involves setting the interest rates and margin requirements. It also uses various tools to influence economic growth, inflation and unemployment.

Some of the Monetary Policy tools are as follows:

• Monetary Base:
  The size of the monetary base can be changed in order to implement the monetary policy. The Central Bank purchases or sells bonds in exchange for hard currency. When the Central Bank collects this hard currency payment, it changes the amount of currency in the economy, thereby changing the monetary base.
  
  
• Reserve Requirements:
  The Monetary policy is often implemented by changing the proportion of assets that banks must hold in reserve with the Central Bank. Banks not only maintain cash for withdrawal but also invest the remaining part on mortgages and loans. The Federal Reserve (Fed) changes the proportion of total assets allotted for loans and this brings about a change in the money supply.
  
  
• Interest Rates:
  In order to fight inflation, the Federal Reserve in the United States changes the monetary policy by varying the Fed Funds rate. The Fed Funds rate determines short term interest rates, which affect the prime rate tied to adjustable rate mortgages including home equity lines of credit. The Fed Funds rate also affects interest rates on other loans, for example, long term fixed rate mortgages.

By changing the monetary policy, the Federal Reserve influences inflation, output and employment. The Fed keeps a watch on the economic indicators in order to determine the direction in which the economy moves. The Federal Reserve forecasts increases in inflation or deflation in the economy and this in turn helps it to know when it should increase or decrease the supply of money.