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Monetary policy is policy that the federal government pursues that aims to keep the economy stable by manipulating the money supply. When the economy is not doing well, the government pursues a loose monetary policy. That means that the government allows the supply of money to grow. When the economy is doing well and is in danger of overheating, the government pursues a tight monetary policy. That means that the government either contracts the money supply or at least does not allow it to grow very quickly.
Monetary policy is conducted by the Federal Reserve. The Fed can do three things to affect the money supply. It can change the percentage of deposits that banks are required to keep as reserves. A higher reserve requirement would be a tight monetary policy while a lower requirement would be a loose monetary policy. The Fed can engage in “open market operations.” This is when the Fed either buys or sells government bonds to banks. A loose monetary policy is when the Fed buys bonds because this puts more money into the economy. If the Fed sells bonds, it takes money out of the economy. This would be a tight monetary policy.
Finally, the Fed can change the interest rate that it charges when it loans money to banks. This is something that gets the most publicity. I have heard many stories about the Fed lowering interest rates, but this has not happened in a few years because the interest rates are very low. Low interest rates encourage borrowing, thus putting more money into the economy. This is a loose monetary policy. Higher interest rates discourage borrowing, thus reducing the supply of money. This is a tight monetary policy.
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