Objectives of Monetary Policy
Economics: IB Diploma, topic 2.6.1
Monetary Policy Objectives
Along with fiscal policy, monetary policy is a tool which is used to smooth business cycles and achieve macroeconomic stability.
Multiple objectives
- In making decisions about the money supply, a central bank decides whether to raise or lower interest rates and, in this way, to influence macroeconomic policy, whose goal is low unemployment and low inflation.
- The central bank is also responsible for regulating all or part of the nation’s banking system to protect bank depositors and insure the health of the bank’s balance sheet.
Central banks around the world
- We call the organization responsible for conducting monetary policy and ensuring that a nation’s financial system operates smoothly the central bank.
- Most nations have central banks or currency boards. Some prominent central banks around the world include the European Central Bank, the Bank of Japan, and the Bank of England.
- In the United States, we call the central bank the Federal Reserve—often abbreviated as just “the Fed.”
Closing output gaps
- Similar to fiscal policy, monetary policy can be used to close output gaps:
- When a recessionary output gap exists, expansionary monetary policy is most appropriate.
- When an inflationary output gap exists, contractionary monetary policy is most appropriate.
Test yourself on Objectives of Monetary Policy
Which of these actions is most appropriate during an inflationary output gap?
Which of these actions is most appropriate during a recessionary output gap?