Monetary policy is the use of monetary levers, interest rates, money supply, foreign exchange rates, by governments to achieve some control over the performance of the economy. We have monetary theory to provide insight into how to draft a monetary policy. Monetary policy is implemented through open market operations. Monetary policy is the process by which the monetary authority of a country controls, the supply of money, availability of money, and cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy.
Gold standard monetary policy was used widely across the world prior to 1971. Monetary policy is now not used anywhere in the world. Fixed exchange rate monetary policy is based on maintaining a fixed exchange rate with a foreign currency. Monetary policy is either an expansionary monetary policy, or a contractionary monetary policy.
The idea of monetary policy as independent of executive action began to be established with the creation of the Bank of England in 1694 which acquired the responsibility to print notes and back them with gold.
Expansionary monetary policy increases the total supply of money in the economy, and a contractionary monetary policy decreases the total money supply. Expansionary monetary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary monetary policy involves raising interest rates in order to combat inflation.
Monetary policy is contrasted with fiscal policy, which refers to government borrowing, spending and taxation. The central bank controls its national money supply by buying and selling government securities, or other financial instruments. Monetary targets, such as interest rates or exchange rates, are used to guide this implementation.
The distinction between the various types of monetary policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals.
In inflation targeting monetary policy approach the target is to keep inflation, under a particular definition such as Consumer Price Index, within a desired range. Price level targeting is similar to inflation targeting but CPI growth in one year is offset in subsequent years such that over time the price level on aggregate does not move.