How to understand monetary policy: The economic control tools in the hands of the Central Bank

Central Bank's Economic “Steering Wheel”

When the economy is overheating, it needs to “hit the brakes”; when the economy is in recession, it needs to “step on the gas”—this is the core function of monetary policy (货币政策). Simply put, monetary policy is a series of actions taken by the Central Bank to manage the money supply and borrowing costs by adjusting interest rates, changing bank reserve requirements, and conducting open market operations.

These policy tools directly affect the lives of ordinary people. When the Central Bank changes its policies, it not only impacts the disposable income of consumers and businesses but also indirectly affects the investment sentiment and capital flow in the cryptocurrency market.

Two Basic Forms of Monetary Policy

Loose Monetary Policy: The Moment for Economic “Boost”

Imagine a country with stagnating economic growth. At this time, the Central Bank would adopt an expansionary monetary policy: lowering interest rates and increasing the money supply to make borrowing cheaper.

What will happen in this environment? Businesses and individuals find it easier to obtain loans. Xiao Wang sees the interest rates on loans decrease and decides to take out a loan to start a business; Xiao Li sees the mortgage costs lower and decides to buy a new house. Increased demand → businesses hire and expand production → economic vitality is restored.

Historical Case: During the 2008 financial crisis, the Federal Reserve significantly lowered interest rates and implemented quantitative easing (purchasing government bonds and mortgage-backed securities). This move increased liquidity in the economy, reduced borrowing costs, and ultimately helped the economy recover from the recession.

In this process, as disposable income increases, more people have the ability to invest in crypto assets such as Bitcoin, which usually drives up the prices of digital currencies.

Tightening Policy: Injection of “Cooling Liquid” into the Economy

When prices soar and the economy overheats, the Central Bank will turn to contractionary policies: raising interest rates and reducing the money supply, making borrowing expensive.

Corporate executives see rising financing costs and pause expansion plans; consumers see higher mortgage interest rates and delay home purchases. Decreased demand → Slower price increases → Inflation is under control.

Practical Example: In the early 1980s, the Federal Reserve raised interest rates significantly to combat double-digit inflation. While this effectively controlled inflation, it also led to a short-term increase in the unemployment rate.

In a tightening environment, people's disposable income decreases, leading to a decline in both the willingness and ability to invest in cryptocurrencies, which in turn exerts downward pressure on coin prices.

How Does Monetary Policy Work?

Monetary policy operates through three main mechanisms:

1. Adjusting the Benchmark Interest Rate — This is the Central Bank's most direct tool, and changes in interest rates will be transmitted throughout the entire financial system.
2. Open Market Operations – The Central Bank influences market liquidity by buying and selling bonds.
3. Modify Reserve Requirements — Changing the percentage of reserves that banks must hold directly affects the amount of funds available for banks to lend.

These tools complement each other and jointly affect the cost and availability of funds in the entire economy.

Monetary Policy and Fiscal Policy: The Differences Between the Two Brothers

The monetary policy controlled by the Central Bank and the fiscal policy controlled by the government are often confused, but there are essential differences between the two:

Different tools of action

• Monetary Policy: Adjust interest rates, reserves, purchase bonds
• Fiscal policy: Adjusting government spending and taxation

Implementation speed varies

• Monetary policy can be deployed quickly, and Central Bank decisions are relatively independent.
• Fiscal policy requires legislative approval, which often takes months or even years.

Scope of application differs

• Monetary policy aims at overall economic goals (controlling inflation, employment)
• Fiscal policy can be targeted to specific industries or groups (tax reductions, directed subsidies)

How Monetary Policy Subtly Affects the Crypto Market

“Gold Rush” in a Loose Environment

When the Central Bank implements an easing policy, cheap funds flood the economy. This means:

• The interest rates on bank loans have decreased, and the returns on deposits have also declined.
• Investors need to look for investment channels with higher returns.
• Cryptocurrency, as a “high-risk, high-reward” asset class, is gaining appeal.
• The prices of Bitcoin and other digital assets often rise.

“capital withdrawal” in a tightening environment

When the Central Bank raises interest rates for tightening, the situation reverses:

• The yields on bank deposits and bonds have become attractive.
• Risk assets have lost their luster
• Investors reduce their allocation to cryptocurrencies
• The currency price is under downward pressure.

Although the cryptocurrency market has its unique logic and cycles, the Central Bank's monetary policy is an important factor influencing its long-term trends—by changing investors' risk preferences and disposable income.

Key Summary

Monetary Policy is a precise tool used by the Central Bank to guide the direction of economic development. Whether through lowering interest rates to stimulate growth or raising interest rates to curb inflation, the ripples of monetary policy will stir the pockets of ordinary people, the ledgers of businesses, and the trends in the cryptocurrency market. Understanding this is crucial for investors to formulate strategies and respond to market changes.