Read the text and name the part Monetary Policy plays in national government's policy.

What is 'Monetary Policy'?

Monetary policy consists of the actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in the vault (bank reserves).

The Federal Reserve is in charge of the United States' monetary policy.

Breaking down 'Monetary Policy'

Broadly, there are two types of monetary policy, expansionary and contractionary. Expansionary monetary policy increases the money supply in order to lower unemployment, boost private-sector borrowing and consumer spending, and stimulate economic growth. Often referred to as "easy monetary policy," this description applies to many central banks since the 2008 financial crisis, as interest rates have been low and in many cases near zero.

Contractionary monetary policy slows the rate of growth in the money supply or outright decreases the money supply in order to control inflation; while sometimes necessary, contractionary monetary policy can slow economic growth, increase unemployment and depress borrowing and spending by consumers and businesses. An example would be the Federal Reserve's intervention in the early 1980s: in order to curb inflation of nearly 15%, the Fed raised its benchmark interest rate to 20%. This hike resulted in a recession, but did keep spiraling inflation in check.

Central banks use a number of tools to shape monetary policy. Open market operations directly affect the money supply through buying short-term government bonds (to expand money supply) or selling them (to contract it). Benchmark interest rates …affect the demand for money by raising or lowering the cost to borrow—in essence, money's price. When borrowing is cheap, firms will take on more debt to invest in hiring and expansion; consumers will make larger, long-term purchases with cheap credit; and savers will have more incentive to invest their money in stocks or other assets, rather than earn very little—and perhaps lose money in real terms—through savings accounts. Policy makers also manage risk in the banking system by mandating the reserves that banks must keep on hand. Higher reserve requirements put a damper on lending and rein in inflation.

In recent years, unconventional monetary policy has become more common. This category includes quantitative easing, the purchase of varying financial assets from commercial banks. In the US, the Fed loaded its balance sheet with trillions of dollars in Treasury notes and mortgage-backed securities between 2008 and 2013. The Bank of England, the European Central Bank and the Bank of Japan have pursued similar policies. The effect of quantitative easing is to raise the price of securities, therefore lowering their yields, as well as to increase total money supply. Credit easing is a related unconventional monetary policy tool, involving the purchase of private-sector assets to boost liquidity. Finally, signaling is the use of public communication to ease markets' worries about policy changes: for example, a promise not to raise interest rates for a given number of quarters.

Central banks are often, at least in theory, independent from other policy makers. This is the case with the Federal Reserve and Congress, reflecting the separation of monetary policy from fiscal policy. The latter refers to taxes and government borrowing and spending.

Objectives of Monetary Policy

The primary objective of central banks is to manage inflation. The second is to reduce unemployment, but only after they have controlled inflation.

The U.S. Federal Reserve, like many other central banks, has specific targets for these objectives. It seeks an unemployment rate below 6.5 percent. The Fed said the natural rate of unemployment is between is between 4.7 percent and 5.8 percent. It wants the core inflation rate to be between 2.0 percent and 2.5 percent. It seeks healthy economic growth. That's a 2-3 percent annual increase in the nation's Gross Domestic Product.

Types of Monetary Policy

Central banks use contractionary monetary policy to reduce inflation. They have many tools to do this. The most common are raising interest rates and selling securities through open market operations.

They use expansionary monetary policy to lower unemployment and avoid recession. They lower interest rates, buy securities from member banks, and use other tools to increase the liquidity.