Monetary policy

Monetary policies are demand-side economic policies through which the central bank of a country acts on the amount of money and interest rates in order to influence on the income levels, output and unemployment in the economy, being the interest rate the link binding money and income. The main tools used by monetary policies are open market operations, loans to commercial banks, and the use of reserve requirements. Ceteris paribus, an increase (decrease) in the money supply or a decrease (increase) in interest rates will have a positive (negative) ripple effect on private spending (consumption and investment). This will finally increase (decrease) production and employment. However, this will increase prices, which may lead to rapidly increasing inflation.

Monetarism is the main economic doctrine that defended this kind of policy. However, Keynesianism, New Classical Macroeconomics and New Keynesian Economics, criticize it and do not believe in their effectiveness as it has been demonstrated that increasing money supply will result in inflation and counteracting the positive effects of this policy. As Milton Friedman said, “inflation is always and everywhere a monetary phenomenon”.