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Monetary Policy is the strategy chosen by a government in deciding expansion or contraction in the country’s money-supply. Actions applied usually through 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

A monetary policy employs three major tools:

(1) Buying or selling national debt

(2) Changing credit restrictions,

(3) Changing the interest rates by changing reserve requirements.

Monetary policy plays the dominant role in control of the aggregate-demand and, by extension, of inflation in an economy.

Monetary policy can be classified as

i)                    Contractionary Monetary Policy

 Is when the Federal Reserve is using its tools to put the brakes on the economy to prevent inflation. This usually means raising the Fed Funds rate to decrease the money supply

ii)                   Expansionary monetary policy

Is when the Federal Reserve is using its tools to stimulate the economy. This usually means lowering the Fed Funds rate to increase the money supply.

If the Federal Reserve is lowering interest rates, it is drawing favorable attention in expansionary monetary policy