What is monetary policy?

Monetary policy is a type of economic policy to control currency, interest rates, and credit for a country. This policy is carried out through a monetary authority.

The authority responsible for this control is the Central Bank, which seeks equilibrium by changing the money supply and determines interest rates, stimulating or reducing the economy.

The money supply occurs based on the liquidity of assets, that is, where goods and services are offered and exchanged for money, always being greater when the economy is healthier.

In times of GDP growth, an economy has more liquidity and in times of recession it is less, therefore, the government controls the money supply seeking a balance between these different scenarios. That is why it is differentiated by expansionary and contractive policies.

Types of monetary policies

Expansive monetary policy

In expansionary monetary policy, the Central Bank increases the country’s money supply and lowers interest rates to grow the economy and expand consumption.

When this is done, the demand for goods and services increases and, with lower interest rates, companies obtain more loans to meet demand. If the supply is not completely satisfied, there will be an increase in prices, that is, an increase in inflation.

Expansionary policy has the advantage of expanding the economy, however, the disadvantage of keeping the country subject to inflation.

Contractive monetary policy

Contractive monetary policy is carried out when the opposite occurs, that is, the decrease in GDP and consumption within an economy.

The Central Bank increases the interest rate, reducing the currency within the economic flow and, with it, the reduction of inflation due to the decrease in demand.

Monetary policy in Latin America

In many Latin American countries, monetary policies are implemented by the Central Bank and are standardized by the National Monetary Council. Interest rates are controlled by the Central Bank’s Monetary Policy Committee.

Through the Central Bank’s Monetary Policy Committee, the government and the Central Bank determine the objectives of inflation control and, therefore, expansionary or contractive policies are implemented, depending on the behavior of the economy.

Some monetary policy operations adopted by the Central Bank in Latin America are:

  • Bank rediscount
  • Mandatory deposit
  • Open market

Fiscal policy and exchange rate policy

Monetary policy together with fiscal and exchange rate policies are formed within the set of economic policies of a country.

Based on these control policies, the methods of the so-called “macroeconomic tripod” were adopted, which join them and form three objectives known as:

Inflation targets  : related to monetary policies and control of interest rates;

Floating exchange rate  : policy  exchange rate  that keeps the free exchange rates in the market;

Objective  tax  : policy objectives  tax  to keep public debt under control.