Monetary Theory
MONETARY THEORY
Monetary theory holds that a government can manage the level of economic activity by controlling interest rates and the amount of money in circulation. In general, pumping more money into the economy leads to more buying and selling; shrinking the money supply leads to less economic activity, possibly even a recession. A tight monetary policy is one that involves higher interest rates and limits the amount of new money going into circulation. An easy or loose monetary policy involves lower interest rates and more money entering circulation. The government agency responsible for the money supply in the United States is the Federal Reserve Board. The Federal Reserve tries to regulate the nation's economic activity by closely watching over the money supply. It has the power to raise or lower interest rates and to control the money supply. Lowering interest rates tends to stimulate the economy; raising interest rates tend to dampen economic activity. Economists often debate the merits of monetary policy. There is no question that too tight a monetary policy can cause an economy to falter. Some historians say the Great Depression (1929–1939), the worldwide economic crisis of the 1930s, was worsened by the government's tight monetary policy of the era. But too loose a monetary policy can also create problems by leading to inflation.
See also: Interest, Money