The use of aggregate quantities of money to influence the economy. For a country to use monetary policy, the environment must be such that the currency of the country is independent of other countries, no fixed exchange rate, no currency area. The use of monetary policy is in contrast to the use of Fiscal Policy, although they can be used together.

Expansionary Monetary policy[]

An increase in the money supply creates a movement along the interest elastic portion of the money demand relationship and the interest rate falls. This stimulates planned investment and generally tends to increases the output of the economy.

For example: One way of expanding the money supply is by a decreasing the reserve requirements for banks.

Problems with this view[]

Keynesian view[]

Strength of monetary policy[]

  • (i) the degree to which the rate of interest falls following an increase in the money supply
  • (ii) the degree to which investment responds to a fall in the rate of interest
  • (iii) the size of the multiplier