How does monetary policy affect your investments?

What do you need to know about monetary policy?

Monetary policy is the set of approaches that central banks use to manage the amount of money in circulation and the financing conditions in the economy. By adjusting interest rates, conducting open market operations, and modifying banking reserve requirements, central banks aim to achieve specific economic goals: controlling inflation, maintaining healthy employment levels, and promoting sustainable economic growth.

In the macroeconomic context, understanding how monetary policy works is essential for any investor, especially for those participating in volatile asset markets.

Two paths: Expansive vs Contractionary

When money flows: expansive monetary policy

Monetary expansion occurs when central banks lower interest rates and increase the amount of money available in the economy. This approach is typically implemented during periods of recession or low growth, aiming to stimulate consumption and investment.

The mechanism is straightforward: with lower interest rates, borrowing becomes more accessible. Consumers more easily access credit for significant purchases, while businesses find it more feasible to finance expansions and new projects. This increased liquidity creates a virtuous circle of demand, investment, and job creation.

A relevant historical case: During the financial crisis of 2008, the U.S. Federal Reserve implemented an aggressive expansionary monetary policy. In addition to drastically reducing interest rates, it launched quantitative easing programs (EC) that included massive purchases of government securities and mortgage-backed securities. This injection of liquidity allowed the markets to gradually recover.

When money contracts: contractionary monetary policy

Monetary contraction represents the opposite scenario. Central banks raise interest rates and reduce the money supply to curb excessive economic growth or combat high inflation. By making money more expensive, it discourages both spending and investment, cooling down an overheating economy.

The consequences are tangible: with higher interest rates, loans become prohibitively expensive, leading individuals and businesses to postpone investment and consumption decisions. This reduction in demand eventually puts downward pressure on prices, controlling inflation.

Historical Reference: In the early 1980s, the Federal Reserve implemented a severe contractionary monetary policy to combat the rampant inflation affecting the United States. Although it significantly reduced prices, this measure temporarily generated higher unemployment, illustrating the delicate balance that central banks must maintain.

Monetary policy vs Fiscal policy: What is the difference?

Both instruments aim to influence the economy, but they operate differently:

Monetary policy allows for more agile responses to economic changes, while fiscal policy provides directional precision in particular sectors.

The direct impact on the crypto markets

Monetary policy does not operate in a vacuum isolated from the cryptocurrency markets. Although bitcoin and other digital assets function in independent systems, investor behavior and the availability of capital are deeply linked to the decisions of central banks.

When the monetary policy is expanded

An expansive monetary policy frees up available capital in economies. Investors with higher purchasing power, low interest rates that penalize traditional savings, and an abundance of liquidity tend to seek higher-yielding investment alternatives. Cryptocurrencies, due to their speculative nature and appreciation potential, benefit from these capital flows. During periods of monetary expansion, we have historically seen upward pressure on the price of bitcoin and other digital assets.

When the monetary supply contracts

The reverse scenario also applies. With higher interest rates, more expensive money, and less liquidity circulating, investors redirect funds towards less risky and fixed-income assets. The capital that used to flow into cryptocurrencies is retracting, potentially putting downward pressure on their valuations.

Summary: What You Should Remember

Monetary policy is the mechanism by which central banks control the money supply and interest rates to achieve macroeconomic objectives. Although it focuses on the traditional economy, its effects directly permeate the investment universe in digital assets.

Understanding the cycles of monetary policy—expansive or contractive—provides you with tools to anticipate movements in market sentiment in cryptocurrency markets. When liquidity increases, investors typically seek greater risk. When money tightens, the opposite occurs.

For those participating in the crypto markets, monitoring decisions from global central banks is just as important as analyzing on-chain metrics or specific technological developments of projects. Macroeconomics and cryptocurrencies are interconnected in ways that any sophisticated investor must understand.