3.5 Monetary Policies

Monetary Policy: Learning outcomes:

• Control of money supply and interest rates by the central bank 

Goals of monetary policy

• Low and stable rate of inflation 

▪ Inflation targeting 

• Low unemployment 

• Reduce business cycle fluctuations 

• Promote a stable economic environment for long-term growth 

• External balance 

• The process of money creation by commercial banks (HL only) 

• Tools of monetary policy (HL only) 

  • Open market operations 

  • Minimum reserve requirements 

  • Changes in the central bank minimum lending rate (base rate/discount rate/refinancing rate changes) 

  • Quantitative easing

  • Demand and supply of money—determination of 

  • equilibrium interest rates (HL only) 

Real versus nominal interest rates 

Expansionary and contractionary monetary policies to close deflationary/recessionary and inflationary gaps 

Effectiveness of monetary policy 

• Constraints on monetary policy, including: 

  • ▪  limited scope of reducing interest rates, when close to zero 

  • ▪  low consumer and business confidence 

• Strengths of monetary policy, including: 

  • ▪  incremental, flexible and easily reversible 

  • ▪  short time lags 

• Strengths and limitations in promoting growth, low unemployment, and low and stable rate of inflation 

Student copy of notes on Monetary Policies

Student worksheet: