What Are the Goals of Monetary Policy?

John Lister

Monetary policy covers national economic decisions that involve the money supply and credit. This is opposed to fiscal policy, which is based around government spending, borrowing and tax-raising. The goals of monetary policy are usually based around stability, particularly in measures such as employment and inflation. For this reason, monetary policy is often handled by a non-political agency.

The Federal Reserve sets US monetary policy in an attempt to maintain a stable economy.
The Federal Reserve sets US monetary policy in an attempt to maintain a stable economy.

The way a country attempts to achieve the goals of monetary policy can vary widely depending on its economic set-up. Although few if any countries have entirely unrestricted free markets or a completely government-controlled command economy, the amount of government intervention is very different around the world. The economic relationships between countries can also affect monetary policy options.

Arguably the most common form of monetary policy is control of the monetary supply. This ranges from the actual amount of physical government-issued cash to the rules governing banks effectively "creating" money by lending it to borrowers and crediting it to their accounts. This in turn influences the amount of business activity that can take place.

The other major action is controlling interest rates. The rates central banks charge commercial banks for short-term loans will usually in turn influence the amount businesses and consumers must pay to borrow money. This in turn affects spending power and the ability to invest to grow a business.

The potential goals of monetary policy are the same in every country, but many countries pick a specific goal, base policy decisions around this goal, and use this measure to track success. The most common is the rate of inflation, which is how rapidly prices increase. Excessive inflation can create a cycle by which consumers have less effective spending power, creating demands for higher wages, which in turn leave companies with less available cash for investment and expansion.

Some countries instead focus on employment levels. This is partly because unemployment can be seen as a societal problem, driving down overall living standards. For countries with generous welfare programs, unemployment can be costly for government, and in any case unemployment usually means lower tax revenues.

Achieving the goals of monetary policy is often a balancing act. For example, low interest rates can help boost employment by making it easier for companies to expand and take on new staff. At the same time, lower rates mean mortgage holders have more disposable cash, risking inflationary pressure. As a result, many monetary policies that have a primary target may still look for overall stability rather than pursuing this target at all costs.

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