What Are the Different Types of Monetary Policy Rules?

Monetary policy rules generally come from a federal government or a central reserve bank; the rules are meant to increase the strength of an economy. Different types of monetary policy tend to fall under large concepts, such as monetary and exchange rate targeting, inflation adjustments, or simply an active policy to do whatever it takes to keep the economy moving. Each of these monetary policy rules has its benefits and drawbacks. In some cases, a country may use more than one of these policies at a time in order to blanket the entire economy with a growth strategy. Free markets tend to have less rules imposed on them, while more controlled markets may have more rules.

Monetary and exchange rate targeting are similar but different monetary policy rules. The former typically controls the amount of money in a market in order to stabilize or prevent inflation. A government can achieve this through adjustment of bank retention rates and credit rules, which restrict or loosen money placed into the market. Exchange rate targeting focuses more on a country’s currency in terms of its strength or weakness against other nations' currencies. A weak currency generally does not allow an economy to remain strong as other nations will most likely not do business in this scenario due to unfavorable exchange rates.

Inflation adjustments through monetary policy rules usually have a goal to stabilize the prices of various goods and services. Monetary policy rules tend to focus only on internal problems or domestic prices, as opposed to goods from foreign markets. For example, changing rules for oil reserves or petroleum supplies due to increased energy prices is a type of inflation adjustment. Again, this policy rule may be used in tandem with monetary targeting, such as lowering the amount of money in the market, which prevents growth and the subsequent inflation. Unfortunately, inflation adjustments can be quite dangerous as the central bank can shock the market and send it into a downward spiral.

The “do whatever it takes” mentality in monetary policy rules requires an overactive government or central bank. No part of the market or monetary policy is off the table in terms of this strategy. A government may use all of the above monetary policy rules and more to spur production, increase consumer spending, control inflation, or strengthen a currency. A problem here, however, is that the economy will become dependent on the government’s actions and may be unable to thrive without it. Once government interaction is removed, the economy may take some time to recover and begin functioning on its own resources.