Central bank policy addresses the issue of how to influence monetary conditions. It is an area that attracts junior to mid-level central bank economists working in monetary policy operations as well as senior central bankers and ministers of finance/economy who have a strong interest in understanding the issue.
The traditional view of monetary policy involves setting an interest rate and mechanically supplying a quantity of reserves to back up that interest rate through open market operations. This approach suffers from two problems. First, it assumes that there is a direct link between the money supply and interest rates. However, there is little if any evidence to support this assumption. Second, the central bank cannot directly control the amount of money in circulation through open market operations. It can, for example, set the amount of money that commercial banks are required to keep on hand and that they cannot loan out; it can buy or sell securities (government IOUs) that commercial banks hold in their accounts at a central bank; and it can conduct a standing repo facility that allows banks to borrow and lend from each other through the central bank with an agreed upon interest rate.
Each of these actions affects the monetary base by increasing or decreasing the amount of money in circulation. A contractionary monetary policy slows down the economy, increases inflation, and reduces employment rates; an expansionary one does the opposite. The central bank cannot directly change prices, so it tries to do so indirectly by changing the money supply. Besides the direct tools of interest rate setting and open market operations, it also has the ability to lend funds to solvent banks in exchange for other assets.