Monetary policy, refers to the policy, of the Central Bank of country with regarded to the supply of money and the rate of interest. Monetary policy is used by the government, through the Central bank, to bring about changes in the economic activity, (viz., income, output, employment, prices, etc.) by changing the supply of money or interest rates. Usually, the monetary authorities set the interest rates at a given level which affects the other economic variables like savings, investment spending and aggregate demand in a manner that result in the GDP and price level changes in the desired direction. The basic premise underlying the operation of the monetary policy is, that, higher interest rates discourage business firms to borrow more funds for investment thus, reducing aggregate spending and lowering aggregate demand. Setting interest rate at a lower level will have the opposite effect, viz., larger borrowings, bigger investment, higher aggregate spending and increase in aggregate demand. Interest rate is thus, used by the monetary authorities as an instrument of monetary policy and is widely used in all economies in their economic stabilization polices.SUBMIT ASSIGNMENT NOW!