Monetary policy is the Federal Reserve’s management of money, credit, and interest rates to achieve macroeconomic goals. This includes efforts to promote economic growth and stability by influencing borrowing costs, making investments that support job creation, and moderating inflation.
Where is the key focus to control economy?
Various tools are used by monetary policymakers to achieve their objectives. These tools need to be easily observable, controllable, easily changes when necessary and tightly linked to their objectives.
History of FED
Preventing bank runs was the Federal Reserve’s primary duty when it was established in 1913.
Congress gave the Fed more authority after the Great Depression of the 1930s, directing it to operate “to effectively advance the goals of maximum employment, stable prices, and reasonable long-term interest rates.”
The Fed has employed an active monetary policy since World War II.
FEDs main measurements (Magic Square)
Price stability
it is a fundamental prerequisite for the smooth functioning of the market economy, sustainable economic growth, and increased economic prosperity. When price stability prevails, changes are easily discernible.
How is price stability determined?
To determine price stability it’s important to look at the inflation rate which should be around 2% every year. This means that products will become 2% more expensive every year. It helps to control growth, boost the economy when needed, and regulate the money supply and interest rates to keep inflation under control as well as growth when necessary.
Currently, the inflation rate is sitting well above the 2% mark and contributes to an unstable market. If you want to learn more about inflation click here.
Employment rate
Consequences of unemployment
Being unemployed can result in low self-esteem, feelings of insignificance, a lack of desire, and a negative impact on the economy.
Policymakers should prioritize job creation since it not only promotes economic growth but also raises citizen well-being. Financial instability, mental health issues, and social isolation can all be brought on by unemployment.
Giving workers a paycheck is one of the employment’s most important responsibilities. People have more confidence to purchase goods and services because of this income, which supports business expansion and job growth.
Additionally, income enables people to save money that can then be invested in projects like starting a business, purchasing a home, or funding other projects that will contribute to economic growth.
Triggering a cycle of economic growth
The economy benefits when firms are successful and generate new jobs. Businesses that grow and generate more revenue contribute taxes that help pay for infrastructure and public services.
Unemployment rate guideline
The unemployment rate is expected to be under 3% which is currently not the case due to low consumer demand. This leads to companies making less money which then leads to layoffs. The unemployed have less money as a result and can consume less which completes the circle.
Economic growth
Long-term investment, which is essential for growth, is encouraged by stable economic growth. Beyond achieving the other aforementioned objectives, it is unclear how much the Fed can promote long-term investment. The president and congress may be in a better position to address the objective of strong and consistent economic growth.
However, one can contend that keeping inflation and interest rates low encourages private sector long-term investment, which in turn supports economic growth.
How is it measured?
Gross domestic product (GDP) is the total worth of all goods and services generated as final goods and services within the national borders of an economy during a year, after deducting all intermediate inputs.
Gross domestic product guideline
It should be at least 2% meaning the more above the better. However, too much GDP growth can also be dangerous, as it will most likely come with an increase in inflation, which erodes stock market gains by making money (and future corporate profits) less valuable.
Balanced trading (External economic equilibrium)
When foreign payments received during a certain period are equal to foreign payments sent during that same period, there is an external equilibrium. The internal link’s sub-balances: Then, the balance of payments is restored.
How is it measured?
According to the Council of Economic Experts, external equilibrium is a state in which there is no likelihood that the external balance of payments will have a detrimental effect on domestic employment or the value of the dollar.
What are the guideline rates?
External equilibrium is achieved when the external contribution as a percentage of nominal gross domestic product is 1-2% per annum and does not exceed 6% in 3 years.