Monetary policy is a set of rules and actions used by a country's central bank to control the money supply and achieve economic stability. It is one of the most powerful tools a government has to manage inflation, employment, and overall economic growth.
The two biggest tools in monetary policy are the bank rate (interest rate) and the reserve requirement ratio. When the central bank raises interest rates, borrowing becomes expensive, people spend less, and inflation cools down. When it lowers rates, borrowing gets cheaper, spending increases, and the economy heats up.
For example, when the US Federal Reserve raised rates to 5.5% in 2023, it was trying to tame inflation that had hit 9.1% the previous year. Monetary policy is like a thermostat for the economy — the central bank adjusts it to keep things from getting too hot or too cold.