Monetary Policy and Central Banking
Source details
- Canonical URL
- Monetary Policy and Central Banking
Other formats
Bibliographic details
- Published: January 13, 2023
- Last updated: April 2025
What monetary policy is and why it is important
- Central banks use monetary policy to manage economic fluctuations and achieve price stability, defined as inflation that is low and stable.
- Many advanced economies set explicit inflation targets; many developing countries are moving to inflation targeting.
- Central banks conduct monetary policy by adjusting the supply of money, usually through buying or selling securities in the open market (open market operations).
- Open market operations affect short-term interest rates, which in turn influence longer-term rates and economic activity.
- When central banks lower interest rates, monetary policy is easing. When they raise interest rates, monetary policy is tightening.
- This factsheet was last updated in April 2025.
How monetary policy has been used recently
- After the global financial crisis that started in 2007, central banks in advanced economies reduced interest rates until short-term rates came close to zero, limiting options for additional cuts.
- Some central banks adopted unconventional monetary policies, buying long-term bonds to further lower long-term rates; some took short-term rates below zero.
- In response to the COVID-19 pandemic, central banks eased monetary policy, provided liquidity to markets, and maintained the flow of credit.
- Many emerging market central banks used foreign exchange interventions and, for the first time, asset purchase programs to mitigate stress in currency and bond markets.
- In response to rapidly growing inflation, central banks around the world tightened monetary policy by increasing interest rates.
- Some major central banks have started making small cuts to interest rates as inflation has fallen from recent highs.
Monetary policy and exchange rates
- A country’s monetary policy is closely linked to its exchange rate regime.
- A country’s interest rates affect the value of its currency; countries with a fixed exchange rate have less scope for an independent monetary policy than those with a flexible exchange rate.
- A fully flexible exchange rate regime supports an effective inflation-targeting framework.
Why countries have macroprudential policies
- The global financial crisis of 2007-2009 showed the need to identify and contain risks to the financial system as a whole.
- Many central banks adopted prudential tools and established macroprudential policy frameworks to promote financial stability.
- Macroprudential tools are used to build buffers and contain vulnerabilities that make the financial system susceptible to shocks, reducing the probability that shocks disrupt financial services and cause serious negative economic consequences.
- Central banks are well placed to conduct macroprudential policy because they can analyze systemic risk and often are relatively independent and autonomous.
- Independence and autonomy are important so the institution responsible for macroprudential policy can withstand political pressures and opposition from industry groups.
The IMF’s role in monetary policy and central banking
- The IMF promotes the effectiveness of central banks through policy advice, technical assistance, and data collection.
- In bilateral policy advice (Article IV consultation), the IMF engages in regular dialogue with country central banks and may provide advice on establishing effective frameworks for monetary policy and macroprudential policy, as well as monetary policy actions.
- The IMF’s Financial Sector Assessment Program (FSAP) provides member countries with evaluations of their financial systems and advice on managing financial stability risks.
- Technical assistance helps countries develop institutions, legal frameworks, and capacity related to monetary policy, exchange rate regimes, or macroprudential policies; it can help countries move toward inflation targeting or improve central bank operations such as open market operations and foreign exchange management.
- The IMF’s Central Bank Transparency Code (CBT) helps central banks guide their transparency practices; CBT reviews conducted by IMF staff provide a view on central bank transparency and facilitate dialogue between central banks and stakeholders.
- The IMF maintains databases to inform policy development and research, including:
- The IMF tracks countries’ monetary policy arrangements (AREAER), central banks’ legal frameworks (CBLD), and monetary operations and instruments (MOID).
- The IMF has an annual survey with details on macroprudential measures and institutions, enabling comparisons across countries and over time.
- The IMF’s comprehensive historical database of macroprudential measures (iMaPP) integrates the latest survey information; IMF economists use the database to measure policy effects; it is freely available to researchers.
- The IMF has comprehensive, structured data on central banks’ direct market interventions; IMF economists used the Central Bank Interventions Database (CBID) to track efforts to support financial markets during the COVID-19 pandemic.
Content in this bundle
References