What is monetary policy?
Monetary policy refers to the actions taken by a central bank or monetary authority to manage the money supply and interest rates in an economy, with the goal of promoting economic growth and stability. To affect the price and accessibility of credit, this may involve altering the money supply, setting interest rates, or using other instruments.
The ultimate goal of monetary policy is to achieve and maintain a healthy economy. This usually involves balancing multiple goals, such as:
To ensure economic stability, lessen the effects of economic crises, and promote sustainable economic growth, central banks carefully control the money supply and interest rates. However, depending on the unique circumstances and requirements of each economy, the exact goals and tactics of monetary policy may change.
Monetary Policy Rates
There are two main types of monetary policy:
- Expansionary Monetary Policy: The goal of an expansionary monetary policy is to boost the money supply and promote economic expansion. Lowering interest rates, expanding the money supply, and relaxing reserve requirements can all be used to accomplish this.
- Contractive monetary policy: Its objective is to reduce the money supply and control inflation. Raising interest rates, reducing the money supply, and increasing reserve requirements can all be used to achieve this.
Different types of monetary policy tools
The tools used to implement monetary policy can be broadly classified into three types:
- Open Market Operations – This involves the central bank buying or selling government securities on the open market to increase or decrease the money supply.
- Interest Rates: The central bank can change the benchmark interest rate, which is the rate at which banks can borrow from the central bank. This influences other interest rates in the economy, which affects borrowing and spending.
- Reserve requirements: The central bank can change the reserve requirements for banks, which affects the amount of funds banks must hold in reserve and can lend.
Other less frequently used tools include discount window lending, moral suasion, and direct checks on bank loans.
Fiat Currency vs. Monetary Policy cryptocurrency monetary policy
To achieve macroeconomic goals such as price stability, full employment, and economic growth, central banks such as the United States Federal Reserve set and implement monetary policies for fiat currencies. To affect the supply of and demand for money in the economy, central banks employ a variety of monetary policy measures, including changing interest rates, engaging in open market transactions, and imposing reserve requirements.
Related: Crypto Resonates Best with BIS’s Vision of the Ideal Monetary System
On the other hand, cryptocurrencies such as Bitcoin (BTC) use decentralized monetary policy, which refers to the approach of controlling the money supply in a cryptocurrency that is based on decentralized algorithmic rules, rather than centralized decision-making by a central authority. or central bank.
In a decentralized monetary system, mathematical algorithms stored in the cryptocurrency software control the creation and circulation of money. This ensures that the money supply remains stable and is not subject to arbitrary changes by a central authority. For example, Bitcoin is restricted to 21 million and its creation rate gradually decreases over time.
There are a number of benefits to decentralizing monetary policy rather than centralization. By setting a more stable and predictable monetary policy, it eliminates the need to rely on a centralized authority and reduces the risk of inflation. Furthermore, it makes it more difficult for governments to manipulate the money supply for political or commercial purposes.
Related: What is the economic impact of cryptocurrencies?
However, decentralized monetary policies also have their challenges. They may not be able to react quickly to changes in market conditions because they are less flexible than centralized monetary policy. Furthermore, the deflationary pressure from the scarcity of various cryptocurrencies can prevent people from investing and spending money.
What will the monetary policy of CBDCs be like?
Since central banks will be able to modify the amount of central bank digital currencies (CBDCs) to meet their macroeconomic objectives, similar to conventional fiat currencies, CBDCs issued by central banks can provide greater control over supply and the demand for money than cryptocurrencies. This indicates that central banks can affect the amount of money in circulation and the demand for it in the economy by altering interest rates, conducting open market transactions, and imposing reserve requirements.
Related: CBDC wholesale vs. Retail CBDC: Key Differences
However, the precise monetary policy of CBDCs would depend on their individual designs and the objectives of the central banks issuing them. The monetary policies of some CBDCs may be more open, while those of others may be more aligned with existing fiat or cryptocurrencies. The developing nature of digital currencies and the requirement for central banks to adopt this new technology will likely ultimately affect CBDC monetary policy.
