It's something the central bank uses to stabilize the economy in the short run
Oh my gosh, this sounds complicated already. Could you explain those to me?
...and there's actually two types of Monetary Policy: Expansionary & Contractionary
It's easier than it sounds. Expansionary policy is when the central bank wants to increase the money supply. They do this to fight recessions, and increase GDP.
If the central bank increases the money supply the interest rate will drop. This will increase investments and consumption!
Okay so far that makes sense... how does the bank even do that though?
It's actually really easy! The bank will buy bonds or otherwise known as Treasury Bills. This increases the amount of money in the money supply, which causes an expansionary effect in the economy
So does the contractionary policy do the opposite of the expansionary policy?
Yes! When the economy is starting to head towards dangerous inflation rates the central bank will start selling bonds, which means there's less money in circulation.
When the bank does this it raises the interest rate. So therefore there are less investments and consumption. This closes the output gap or also known as the aggregate demand gap causing the inflation
These bond thingies sound like a scam. Why would I spend money to lose money if the economy is in trouble? I'd love to help but I don't want to be poorer
You actually make money off of them because they collect interest. So you're spending money to make money! If u spent 100$ today in 10 years you'd probably have about 125$ depending on the rate of interest.