6 questions to understand monetary policy

THE monetary policy is one of the main tools used by central banks to manage a country's economy.

It directly affects the money supply and interest rates, influencing inflation, economic growth, and even the job market.

But despite its importance, the concept of monetary policy often seems distant to most people.

In this article, we'll answer six key questions that will help you better understand what monetary policy is, its impacts, and the challenges it faces in 2024.

What is monetary policy?

THE monetary policy refers to the set of measures adopted by a country's central banks, such as Central Bank of Brazil or the Federal Reserve (FED) in the United States, to control the money supply and interest rates.

The main objective of these measures is to ensure price stability, that is, to control inflation and, at the same time, to promote sustainable economic growth.

There are two main types of monetary policy:

• Expansionary Monetary Policy: Used when the economy is slowing or in recession, this type of policy seeks to stimulate economic growth. It does so by reducing interest rates and increasing the money supply, encouraging consumption and investment.
• Contractionary Monetary Policy: This policy is adopted when inflation is high. The goal is to reduce inflationary pressure by raising interest rates and restricting the money supply.

In 2024, expansionary monetary policy has been adopted by several countries, including the United States, following the COVID-19 pandemic and its prolonged effects on the global economy.

With the slowdown in production chains and rising inflation, central banks have opted for constant adjustments in interest rates to balance growth and stability.

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What are the main instruments of monetary policy?

Central banks have several instruments at their disposal to implement the monetary policy. Among the main ones are:

• Basic interest rate (Selic in Brazil): The base interest rate serves as a benchmark for other interest rates in the market, influencing the cost of credit for businesses and consumers. A lower interest rate encourages consumption and investment, while a higher rate has the opposite effect, discouraging credit and consumption.
• Open market operations: These involve the purchase and sale of government bonds by central banks. When the central bank buys bonds, it injects money into the economy, increasing liquidity and stimulating consumption. Bond sales, on the other hand, remove money from circulation, controlling inflation.
• Reservation requirements: Refers to the amount of money banks must hold as reserves relative to the deposits they receive. Raising requirements reduces the amount of money available for lending, which can slow the economy. Lowering requirements has the opposite effect, stimulating credit granting.

These instruments are used according to the objectives of monetary policy at any given time.

In 2024, many central banks, including the European Central Bank (ECB), continue to adjust their policies to control inflation without compromising economic growth.

How does monetary policy impact inflation?

Monetary policy is a fundamental tool in combating inflation.

Inflation occurs when there is a widespread and continuous increase in the prices of goods and services, which reduces the purchasing power of the currency.

When inflation is high, the central bank may adopt a contractionary monetary policy, increasing interest rates to reduce available credit and curb consumption.

With less demand for products and services, prices tend to stabilize.

A practical example can be seen in the Brazilian economy. In 2024, the Central Bank of Brazil managed to stabilize inflation, which remained below 5%, a positive result compared to post-pandemic inflation rates.

The increase in interest rates, which reached 13.75% in 2023, helped to contain the inflationary escalation.

According to the World Bank, global inflation, caused by rising commodity prices and disruptions in production chains, has been one of the biggest economic challenges in recent years.

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How does monetary policy affect economic growth?

Monetary policy has a direct impact on economic growthWhen the central bank adopts an expansionary policy, lowering interest rates and injecting more money into the economy, consumption and investment increase, boosting growth.

However, this policy can also generate inflationary pressures, as an increase in demand for goods and services can raise prices.

On the other hand, a contractionary monetary policy, by raising interest rates and reducing liquidity, can slow down the economy, as credit becomes more expensive and consumption decreases.

This slowdown may be necessary in times of high inflation, but it can also lead to recession if implemented too aggressively.

The dilemma facing central banks in 2024 is precisely finding the balance between stimulating economic growth and controlling inflation.

According to the International Monetary Fund (IMF), the monetary policies of the world's major central banks will be challenged by the still-persistent effects of the pandemic, in addition to the political and geopolitical uncertainties impacting global markets.

What is the difference between monetary policy and fiscal policy?

Although they are often confused, the monetary policy and the fiscal policy are different tools of economic control.

Monetary policy, as we have seen, is conducted by central banks and refers to the control of the money supply and interest rates.

Fiscal policy is the responsibility of governments and involves the management of public revenues and expenditures, such as taxes and government spending.

Both influence the economy, but they act in different ways. Fiscal policy directly affects aggregate demand through changes in tax levels and public spending.

For example, in 2024, the Brazilian government implemented an expansionary fiscal policy, with an increase in public spending to boost strategic sectors of the economy, such as infrastructure and technology.

On the other hand, monetary policy has a more immediate impact on credit and liquidity in the economy.

A classic example of the interaction between these two policies is when the government increases public spending to stimulate growth and, simultaneously, the central bank raises interest rates to control inflation.

What are the challenges in 2024?

In 2024, the monetary policy faces new challenges in a complex global scenario marked by economic, political, and climate uncertainty. Key challenges include:

• Persistent inflation: Although many countries have managed to reduce inflation compared to the peaks of 2022 and 2023, it remains above targets in many economies. According to the World Bank, global inflation in 2024 remains above 4%, and the challenge for central banks is to keep inflation under control without harming economic growth.
• Fragile economic growth: Despite efforts to stimulate the global economy, growth remains slow, especially in developed economies. Expansionary monetary policy alone has not been enough to reverse this situation, requiring a combination of more aggressive fiscal policies and investments in strategic sectors.
• Geopolitical uncertainties: Conflicts such as the war in Ukraine and trade tensions between the United States and China continue to affect global markets, creating volatility and uncertainty. This makes the task of central banks even more challenging, as they must balance monetary policy with a constantly changing global environment.

Monetary Policy	Objective	Instruments Used
Expansionist	Stimulate economic growth	Reduction of interest rates
Contractionist	Reduce inflation	Increase in interest rates
Neutral	Maintain stability	Interest rate maintenance

Conclusion

Understand the monetary policy It is essential for anyone who wants to follow the economic scenario and its impacts on daily life.

In 2024, central banks face the challenge of balancing the fight against inflation with the need to stimulate economic growth in a volatile global environment.

The decisions made by these bodies directly affect consumption, investment and the cost of living, making it essential to understand the instruments and objectives of this policy.

Monetary policy, in addition to being a technical tool, is also a matter of public trust, as the economist rightly puts it. Joseph Stiglitz:

“Monetary policy is, above all, a tool of public trust; a transparent policy can guide expectations and stabilize markets.”

Therefore, it is up to central banks to continue closely monitoring economies and adjusting their policies as necessary, always aiming to ensure financial stability and the economic well-being of the population.