Monetary policy and the role of Central Bank

The policy with which the Central Bank controls the money supply in the economy is called the monetary policy. As Central Bank reduce the money supply in the market the interest rate increases or the other way we can say that to increase the Market interest rate the Central Bank reduces the money supply. Now the question arises that how the Central Bank do so? The simplest answer to this question is open market operations by the Central bank. In open market operations the central bank purchases or sales the bonds, security and treasury bills‎ in open market to control the money supply and inflation rate. When it purchases the bonds, securities and TB from market the money supply in the market increases and increased money supply leads to lower market interest rates. These lower interest rates or low cost of borrowing encourages the borrowers. As a result the domestic consumption increases this leads to demand pull inflation in the economy. So with the help of tight monetary policy the Central Bank increases the policy rate to control the inflation.