If you’re familiar with fundamental analysis, you will find monetary policies a very crucial factor to consider when trading forex.
National governments and their central banks develop and create their monetary policies in order to accomplish certain Video Tutorials economic goals and targets.
Central banks set the country’s currency’s Contract for Difference interest rates as well as the whole monetary policy in that country. The end goal of such formulation is to promote and maintain price stability and economic growth.
Now, there are different types of monetary policies, and we’ll explain them one by one. So read on!
Contractionary or Restrictive Monetary Policy
This type of monetary policy happens if it reduces or decreases the size of the money supply. This can also take place when there is an interest rate hike.
The idea behind this policy is to slowdown the economic growth of a country by imposing high interest rates. Higher interest rates means that participants cannot borrow money as easily as before, plus it become more expensive. This in turn reduces spending and investments by consumers and businesses in that country.
Expansionary Monetary Policy
This monetary policy, on the flip side, is the polar opposite of the contractionary or restrictive monetary policy.
This one expands or swells the country’s money supply. This also decreases the interest rate.
Borrowing money would be cheaper with the hopes of spurring the spending and investing activities of consumers and participants.
Accommodative Monetary Policy
This monetary policy, meanwhile, tries to create economic growth by lowering the interest rate. Then, tight monetary policy is scheduled to minimize inflation or retrain economic growth by raising interest rates.
Neutral Monetary Policy
This one, as its name suggests, aims to neither create growth nor fight against inflation.
Why do banks use different monetary policies?
The simple explanation to this question would be this: central banks have an inflation target in mind. They might be trying to get inflation at a level near 2 percent, or 3 percent, whichever is healthy for the country.
Even if central banks do not announce such targets, all monetary decisions and moves are intended to achieving the inflation target.
Why do they want to control inflation?
Inflation, if controlled, can be good for the economy. But if goes out of control, it will definitely harm the economy of that country.
Remember that inflation is the increase in the price of goods. Inflation is a good thing for the economy if it boosts growth. If the central banks and the government fail to control it, it will to people having less confidence in their economy, their job, and the value of their money.
Central banks help market participants understand how they are planning to deal with the current economic landscape. Overall, the market can be said to be in good hands when it understands why the central bank does or doesn’t take any action regarding its target interest rate.
Monetary policies are made for good reasons. Depending on the central bank’s targets, investors and traders may use this knowledge of the central bank’s plan for setting up strategic trading plans.