Monetary policy is what central banks do to manage money and credit. They adjust interest rates, buy or sell government securities, and set reserve requirements. The goal is usually to keep inflation low and stable while supporting employment.

The main tool is the policy interest rate. Lower rates make borrowing cheaper, which encourages spending and investment. Higher rates do the opposite, cooling an overheating economy. During severe crises, central banks may use quantitative easing, buying assets to inject money directly into the financial system.

Monetary policy works with a lag. A rate change today may take a year or more to affect inflation and jobs. Central banks try to forecast, but forecasts are imperfect. They also face pressure from politicians who want lower rates before elections. Independence helps insulate them, though it is never absolute.

Key tools

• Policy interest rate
• Open market operations
• Reserve requirements
• Quantitative easing
• Forward guidance