Monetary Policy Definition
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What is Monetary Policy?
To define monetary policy, it refers to the financial policies adopted by the monetary authority of a country, such as the Federal Reserve, to achieve the country’s economic goals.
These goals are often a combination of economic growth, price stability and credit availability.
What are the Types of Monetary Policy?
Monetary policies are generally categorized as either expansionary or contractionary.
- Expansionary policies are used to accelerate the economy by making capital easily accessible.
- Contractionary policies are used to fight inflation and slow economic growth when necessary.
While expansionary policy may seem more intuitive, both expansionary and contractionary policies are needed for the long-term health of an economy.
For example, expansionary policy’s low interest rates can result in harmful levels of inflation and undisciplined investments, forming economic bubbles.
Unlike fiscal policy, which pertains to policies on government taxation and spending, monetary policy is independent from the political process.
The Federal Reserve operates autonomously in order to shield it from short-term political pressures, such as a presidential election.
This ensures that the Federal Reserve may make the best decisions for the long-term health of the economy.
What is the Objective of U.S. Monetary Policy?
According to federalreserve.gov, “Congress has directed the Fed to conduct the nation’s monetary policy to support three specific goals:
1. Maximum sustainable employment
2. Stable prices
3. Moderate long-term interest rates
To achieve these goals, the Federal Reserve institutes three categories of monetary policy:
- Open market operations: The Fed’s purchase and sale of securities in the open market in order to regulate the money supply.
- The discount rate: The interest rate charged to commercial banks on debt borrowed from “the discount window,” or the Federal Reserve Bank’s lending facility.
- Reserve requirements: The amount of funds banks are required to hold in its reserves in order to meet its liabilities.