Optimal monetary policy refers to the efforts by central banks in various countries to control the monetary supply so that they can achieve the best overall effects on the economy. By changing the amount of money that flows through an economy, these institutions are essentially changing the purchasing power of consumers and businesses and affecting their ability to get credit. There are several different ways that an optimal monetary policy may be achieved, including purchasing or selling government bonds, changing reserve requirements for banks, and taking actions which affect the interest rates for borrowing. All of these measures are intended to stimulate economic growth, keep unemployment at a minimum, and control inflation.
There is often debate in an open economy about how much action a centralized economic body should take to try and stimulate that economy. Some argue that the economy itself will balance out due to the normal forces of supply and demand. Others feel that certain dire economic circumstances require the government to exert its economic powers to turn things around. Any time a central bank in a country takes action, it is attempting to do so with an optimal monetary policy as its goal.
It is important to understand the goals that an economy wants to achieve before an optimal monetary policy can be enacted. Economic growth is a common goal for economies, especially in terms of consumption and production levels on a countrywide basis. Inflation must be controlled in tandem with that growth, which can be difficult because the two forces often work in opposition to each other. Employment levels are also closely monitored by governments as a sign of economic strength.
Achieving these goals with an optimal monetary policy entails changing the amount of money flowing through a society. It is a delicate process, since such action is essentially changing the value of money in that economy. This can cause rising inflation if money is cheapened too much, and it can affect growth if money is too difficult to gather. In addition, the value of currency is extremely important to monitor in a global economy where international transactions are commonplace.
Knowing all of these factors, centralized economic authorities have different ways to construct an optimal monetary policy. Buying up existing government bonds will increase the monetary supply and lower interest rates, while selling them will have the opposite effect. In addition, a central bank may force a change in the reserve requirements of banks throughout the country. If banks have to keep more in reserve, there will be less money in the economy and credit will be more difficult to obtain. Less money needed in reserve means that banks can afford to be more lenient in lending, thereby putting more money in the economy.