Monetary

This policy looks at the management of the supply of money, availability of money and the cost of money (i.e. interest).

It:

  • Affects interest rates
  • Can help reduce unemployment
  • Can control inflation

There are two measures of money supply:

  • M0 - Notes and coins in country’s Central Bank
  • M4 - Notes and coins in private sector banks

In essence the government controls the amount of money in circulation through the buying and selling of government bonds. Where they believe there is too much money is circulation then they sell bonds resulting in then receiving cash (therefore taking it out of the economy) and when they wish for more money in the economy they buy these bonds therefore putting that money back into circulation.


How does the money supply affect the economy?

Where there is a high supply of money in the economy it results in lower interest rates as the banks have plenty of money to lend, but this can also decrease the value of the currency as the money is in abundance and hence less in demand. Furthermore it can speed up inflation as consumers have more disposable income to spend. The increasing of monetary supply is referred to as an expansionary policy. This is also known as quantitative easing.

The reverse is the case for a low supply of money; referred to as a contractionary policy. Hence the government controls the money supply so as to influence interest and exchange rates as well as inflation.