What is monetary policy?
Monetary policy is the control of interest rates and the money supply, usually by a country's central bank, to influence the level of demand in the economy. The interest rate is the cost of borrowing money and the reward for saving.
Key idea
Lower interest rates make borrowing cheaper and saving less attractive, so households and firms tend to spend more, raising demand.
How interest rates work
If a central bank raises interest rates, borrowing becomes more expensive and saving more rewarding, so spending and investment fall. This lowers demand and can help control inflation. If it lowers interest rates, spending and investment rise, which can boost growth and reduce unemployment but may increase inflation.
Supply-side policy
Supply-side policies aim to increase the economy's ability to produce, shifting productive capacity upward over the long term. They work on the supply of goods and services rather than on demand. Examples include improving education and training, cutting taxes on firms to encourage investment, and improving infrastructure such as transport.
Remember
- Monetary and fiscal policy mainly affect demand.
- Supply-side policy mainly affects the economy's productive capacity and often works slowly.