Types and Mechanisms of Monetary Policy: How They Affect Your Investment Decisions

Quick Overview

Monetary policy (货币政策) is the central bank's core tool for regulating the money supply and borrowing costs. By adjusting interest rates, conducting open market operations, and changing bank reserve requirements, the central bank influences the overall pace of economic activity. The effects of this policy framework are directly transmitted to the cryptocurrency market—expansionary policies typically drive up digital asset prices, while contractionary policies may trigger adjustments.

What is Monetary Policy

Monetary policy is a series of actions taken by the central bank to achieve specific economic goals. These goals include: controlling inflation, adjusting employment levels, and promoting economic growth.

The main tools of the central bank include:

• Adjusting the benchmark interest rate — affects interbank financing costs, which in turn impacts the entire economy.
• Open Market Operations — Buying and selling government bonds and other financial assets to increase or decrease liquidity
• Reserve Requirement — Changing the reserve ratio that commercial banks must hold directly affects their lending capacity.

By regulating the money supply and borrowing costs, the central bank can stimulate economic activity and also apply a cooling effect when the economy is overheating.

The Two Main Types of Monetary Policy

1. Expansionary Monetary Policy (Easy Policy)

The characteristic of expansionary policy is to lower interest rates and increase the money supply. This approach aims to stimulate economic activity during periods of economic recession or low growth.

Operation Principle: A decrease in interest rates reduces borrowing costs, making it easier for businesses to obtain investment funds, and consumers are more inclined to apply for loans to buy homes or cars. This “cheaper money” state increases disposable income in society, promoting consumption and investment.

Real Case: Taking the 2008 global financial crisis as an example. The Federal Reserve not only significantly lowered interest rates but also implemented Quantitative Easing (QE)—directly purchasing government bonds and mortgage-backed securities. These actions injected massive liquidity into the economy, ultimately helping the financial system recover and gradually reducing the unemployment rate.

2. Contractionary Monetary Policy (Tightening Policy)

The characteristic of contractionary policy is to raise interest rates and reduce the money supply. This approach is used to control high inflation and cool down an overheated economy.

Mechanism: Rising interest rates make borrowing more expensive. Consumers take out fewer loans, and businesses delay investment plans. Disposable income decreases, overall demand declines, and ultimately curbs price increases.

Historical Reference: In the early 1980s, Federal Reserve Chairman Volcker faced inflation rates reaching double digits. He adopted aggressive tightening policies and significantly raised interest rates. Although this led to a rise in unemployment and an economic slowdown in the short term, it successfully defeated inflation and laid the foundation for subsequent economic prosperity.

Monetary Policy vs Fiscal Policy: What is the Difference

How Monetary Policy Affects the Cryptocurrency Market

Although the digital asset market has a certain degree of independence, changes in monetary policy can have a profound impact on it. This is because investors' investment decisions are influenced by their disposable income and risk preferences.

The cryptocurrency market under expansionary policies

When the central bank releases liquidity, the amount of “cheap money” in society increases. Investors have more available funds, and more people are willing to take risks by investing in Bitcoin and other crypto assets. Historically, many bull markets have been accompanied by cycles of expansionary policies from central banks - ample liquidity drives up the prices of risk assets.

The cryptocurrency market under contraction policy

Rising interest rates mean that holding cash and bonds becomes more attractive. Investors' disposable income is constrained, and risk appetite decreases. In such an environment, the demand for risk assets like cryptocurrencies shrinks, and prices typically face pressure. Many crypto investors will reassess their positions, which may lead to sell-offs.

Key Points Summary

1. Monetary policy is the central bank's core tool — It influences the economy by adjusting interest rates and the money supply.
2. Policies are divided into two main types — expansionary (stimulating growth) and contractionary (controlling inflation)
3. Policy effects are delayed — It takes months or even longer for the market to respond after implementation.
4. The crypto market is not independent — Changes in macro monetary policy will be transmitted to digital assets through investor behavior and liquidity.
5. Understanding the policy cycle is important — it has reference value for long-term investment decisions.

Tracking the policy signals of central banks and understanding the performance of various assets in different monetary policy environments is a compulsory course for mature investors. Whether it is stocks, bonds, or cryptocurrencies, all will be affected by this “economic environment”.