Monetary Theory

DEFINITION of 'Monetary Theory'

A set of ideas about how monetary policy should be conducted within an economy. Monetary theory suggests that different monetary policies can benefit nations depending on their unique set of resources and limitations. It is based on core ideas about how factors like the size of the money supply, price levels and benchmark interest rates affect the economy. Economists and central banking authorities are typically those most involved with creating and executing monetary policy.

BREAKING DOWN 'Monetary Theory'

In many developing economies, monetary theory is controlled by the central government, which may also be conducting most of the monetary policy decisions. In the U.S., the Federal Reserve Board sets monetary policy without government intervention. The Federal Reserve operates on a monetary theory that focuses on maintaining stable prices (low inflation), promoting full employment and achieving steady growth in gross domestic product (GDP). The idea is that markets function best when the economy follows a smooth course, with stable prices and adequate access to capital for corporations and individuals.

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