The means by which entities, as government agencies, as the
Federal Reserve, Department of the Treasury, and institutions as the central bank, control the supply of money (M1, M3). This process includes trading in
foreign exchange markets.
Monetary policy can but viewed in its two forms: expansionary and contractionary. Expansionary policy increases the total money supply (liquidity) and is used to fight unemployment or recessionary pressures, mainly by lowering interest rates. Direct cash infusions to struggling private institutions or government rebates to individuals can be used as emergency measures to avoid panic runs on banks as was seen in the 1929 market crash. These measures are very dangerous and are considered highly inflationary and destabilizing to currency exchange rates. Economic theory would indicate that such uncontrolled printing of money, indicates failure of fiscal policy (which refers to government borrowing, spending, and taxation).
Contractionary policy is used to control inflation by
raising interest rates. A "
perfect storm" scenario would be when a government "should be" using a contractionary policy and resorts to an expansionary policy.
