Question

monetary policy involves decreasing the money supply.

Answer 1

Not exactly — decreasing the money supply is one form of monetary policy (specifically contractionary monetary policy), but monetary policy more broadly can be either contractionary or expansionary depending on the economic goal.

Key points:
- Contractionary monetary policy: central bank acts to reduce money growth or tighten liquidity to lower inflation or cool an overheating economy. Tools include selling government securities (open-market sales), raising the policy interest rate, increasing reserve requirements, and quantitative tightening (reducing the central bank’s balance sheet). Effects: higher interest rates, lower investment and consumption, slower growth, lower inflation, possible rise in unemployment, and often an appreciation of the currency.
- Expansionary monetary policy: central bank increases money supply or eases liquidity to stimulate growth (used in recessions). Tools include buying securities (open-market purchases), lowering the policy rate, reducing reserve requirements, and quantitative easing. Effects: lower interest rates, more borrowing and spending, higher growth and employment, and upward pressure on inflation and asset prices.
- In practice modern central banks typically target an interest rate (or inflation) rather than directly controlling monetary aggregates (M0, M1, M2), so they influence the money supply indirectly through policy rates and balance-sheet operations.
- Examples: Volcker Fed (early 1980s) tightened policy to crush high inflation; the Fed and other central banks used aggressive easing (QE) after 2008 and 2020 crises.

So yes — “monetary policy involves decreasing the money supply” describes contractionary policy, but monetary policy can also involve increasing the money supply depending on the objective.