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The actions taken by a central bank to manage the money supply, interest rates, and credit conditions to achieve economic objectives like price stability and full employment.
The Federal Reserve conducts monetary policy primarily through three tools: setting the federal funds rate, open market operations (buying/selling government securities), and reserve requirements. Expansionary (dovish) policy involves lowering rates and injecting liquidity to stimulate growth. Contractionary (hawkish) policy involves raising rates and reducing liquidity to fight inflation. Monetary policy operates with a lag of 12-18 months, meaning the effects of today's decisions are felt well into the future. The Fed's dual mandate is to promote maximum employment and stable prices (targeting 2% inflation).