What is the meaning of the monetary policy?

Preface

Recently, central banks of various countries have launched a war on interest rate hikes! In particular, the Federal Reserve has been raising interest rate expectations to curb inflation. But do you know what the central bank’s monetary policy is? What are the monetary policies?

What is the meaning of the monetary policy?

Monetary policy refers to a country’s means of influencing other economic activities by controlling the supply of money.
In most countries it is the central bank that performs this task.
However, not every country’s central bank is owned by the government. Some countries’ central bank shares are even privately owned.
For example, the Federal Reserve (Fed) is the central banking system of the United States, but it is not entirely owned by the government. Some shares are even in the hands of private banks, and many decisions are independent of the government.
Economists, investment analysts and investors in general pay close attention on central bank monetary policy decisions because of their long-term effects on the economy as a whole and specific industries.

The objectives of monetary policy

1. Maintain steady growth of GDP
2. Keep inflation within a predictable range
3. Keep unemployment low
4. Promote financial stability
5. Sound banking business
6. Maintain the stability of domestic and foreign currency values

The type of monetary policy

Monetary policy is mainly divided into the following two types: expansionary monetary policy and contractionary monetary policy.

Expansionary monetary policy

Also known as a dovish stance. When the economy slows down or recession, and the unemployment rate rises, the Fed will cut interest rates (cut interest rates), buy bonds, and increase the money supply to make people’s savings less attractive, and then encourage people to use money for investment or consumption.
Simply put, it means lowering interest rates and increasing liquidity in the market. When the interest rate is lowered, the borrowing cost of people and companies is lower, and the money deposited in the bank can only get a lower interest rate, which will relatively increase the willingness to invest and encourage people to use the funds.
However, it should be noted that the rapid increase in the money supply is likely to cause inflation.
Example: The global outbreak of COVID-19 in March 2020, the stock market crashed, and unemployment rose sharply. The Federal Reserve announced a quantitative easing policy of 700 billion yuan on March 15, and expanded quantitative easing to unlimited on March 23.

Contractionary monetary policy

Also known as a hawkish stance. When inflation is too high or the economy is overheating, the Fed will slow the money supplying and reduce inflation by raising interest rates, selling bonds, and reducing the money supply.
Simply put, it is to increase market interest rates and reduce liquidity. When interest rates rise, borrowing costs for individuals and businesses increase, and money deposited in banks can get higher rebates, people will not be willing to let funds take more risks, which will reduce liquidity in the market.
But raising interest rates could slow the economy and even increase unemployment, though it’s considered necessary to curb inflation and cool the economy.

What is the impact of monetary policy on investors?

Cash

Loose monetary policy can cause savers to be reluctant to put their money in the bank and instead invest it for higher returns. However, tightening policies may induce consumers prefer to spend money more than saving, and even invest in the market.

Stock

Loose monetary policy leads to low borrowing costs, and people are more willing to invest their money in stocks to pursue higher returns, which is beneficial to the stock market. On the contrary, tight monetary policy limits risk appetite.

Commodity

Loose monetary policy stimulates economic growth, resulting in strong demand for commodities; commodities trade in a stock-like manner during periods of tightening, slowing economic growth and demand for commodities as interest rates rise, but the upward trend is likely to remain in the early stages of tightening.

Domestic currency

Loose monetary policy means increasing the circulation of the domestic currency and lowering interest rates, which will lead to a sharp depreciation of the domestic currency; tight monetary policy reduces the supply of the domestic currency and raises the interest rate, which will help the domestic currency to appreciate.

Real estate

Real estate usually performs well during low interest rates, because low borrowing costs make it cheaper for people to hold a house; high interest rates are not favorable for real estate, because the cost of repaying loans increases, resulting in a decline in demand from homeowners and investors.

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