Monetary Policy

Answer 1

There are a few tricks up the government’s sleeves when it comes to trying to regulate the economy. But why would the government want to do such a thing? Since the fading of the laissez faire view that governments should keep their noses out of peoples’ economic activities, governments have been using both fiscal policy and monetary policy to help regulate the economy. They are seeking stable growth, because unchecked growth can lead to high inflation and economic implosion.

Generally there are three important goals of using either fiscal or monetary policy. They are to keep inflation at low levels, maintain overall stable growth, and try to keep employment levels as close to full employment as possible.

Last time I spoke about fiscal policy and how it uses changes in taxation and government spending to aim for those three goals. Today, the topic is monetary policy. This set of tools works by tweaking interest rates to adjust the supply of money in the economy. The theory goes that when interest rates are lowered it tends to increase economic activity. Businesses can access credit more easily, so they invest in capital projects they’ve been sitting on. The same goes for consumers – when rates are lowered you’re more likely to buy a car, use the credit card, or finally put that addition on the house; all things that help to stimulate the economy. Should the economy begin to grow too quickly it could illicit worries about inflation. When that happens, the Fed can tighten up the money supply by increasing interest rates. This has the effect of slowing things down.

Monetary policy is usually used to fine tune the rates of inflation and employment. In more serious economic times it is often necessary to combine the use of monetary policy with fiscal policy in a well orchestrated united front.

Monetary policy can also involve some more complex tools including open market operations and quantitative easing, which you may have recently heard about. But these are tools that are rarely used. Usually, monetary policy is relegated to the Federal Reserve’s decisions on where to set interest rates.