In
practice, to implement any type of monetary policy the main tool used is
modifying the amount of base money in circulation. The monetary authority does
this by buying or selling financial assets (usually government obligations)
these open market operations change either the amount of money or its liquidity
(if less liquid forms of money are bought or sold) the multiplies effect of
fractional reserve banking amplifies the effects of these actions. Constant
market transactions by the monetary authority modify the supply of currency and
this impacts other market variables such as short term interest rates and
exchange rate.
The distinction between the various
types of monetary policy lies primarily with the set of instruments and target
variables that are used by the monetary authority to achieve their goals. However, monetary policy can be
expansionary or contractionary. According to Jhingan (2003:619) an expansionary
monetary policy is used to overcome a recession or a depression or a
deflationary gap.
Contractually, monetary policy is a
monetary policy that seeks to reduce the size of the supply of money while
expansionary monetary policy is a policy that seeks to increase the size of the
money supply.
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