The Impact of Monetary Policy on the Stock Market

By Stock Research Pro • March 26th, 2009

Monetary policy describes the actions taken by the Federal Reserve (The “Fed”) to influence the cost and availability of money and credit. At any time, The Fed may initiate “expansionary” (to increase the money supply) or “”contractionary” (to decrease the money supply) policy as a means to promote overall economic goals. The actions the Fed takes with regard to monetary policy can have a significant impact on interest rates and the performance of the economy and the stock market.

Goals of Monetary Policy

Expansionary Monetary Policy is implemented in an effort to encourage economic growth. Expansionary Policy is implemented for managing low-growth periods in the business cycle. The primary risk associated with expansionary policy is the possibility of increased inflation. This policy seeks to lower interest rates to promote borrowing and expansion.

Contractionary Monetary Policy is implemented when the Federal Reserve decreases the money supply to slow the economy and prevent inflation. This policy causes interest rates to increase so that consumers borrow and spend less. This policy also causes prices to stabilize.

Tools of Monetary policy

The Federal Reserve implements monetary policy through three primary mechanisms:

Open market operations: Buying and selling of United States Treasury and other federal agency securities on the open market

Discount window lending: The Federal Reserve Bank’s lending to depository institutions at set rates

Reserve requirements: The requirements for the amount of money that depository institutions must hold in reserves against deposits made by their customers

How Monetary Policy Can Influence the Stock Market

The Fed implements monetary policy to help manage short-term economic output and employment and, over the longer-term, help smooth out the business cycle. Many investors believe a good strategy is in following the path of current monetary policy, investing in “non-cyclical” types of stocks (e.g. utilities and healthcare) during times of contraction and more “cyclical” stocks (e.g. financials and technology) during times of expansion.


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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