Goals of Monetary Policy
The goals of monetary policy are spelled out in the Federal Reserve
Act, which specifies that the Board of Governors and the Federal Open Market
Committee should seek “to promote effectively the goals of maximum employment,
stable prices, and moderate long term interest rates.” Stable prices in the long
run are a precondition for maximum sustainable output growth and employment as
well as moderate long term interest rates. When prices are stable and believed
likely to remain so, the prices of goods, services, materials, and labor are
undistorted by inflation and serve as clearer signals and guides to the
efficient allocation of resources and thus contribute to higher standards of
living. Moreover, stable prices foster saving and capital formation, because
when the risk of erosion of asset values resulting from inflation, and the need
to guard against such losses, are minimized, households are encouraged to save
more and businesses are encouraged to invest more.
Although price stability can help achieve maximum sustainable output
growth and employment over the longer run, in the short run some tension can
exist between the two goals. Often, a slowing of employment is accompanied by
lessened pressures on prices, and moving to counter the weakening of the labor
market by easing policy does not have adverse inflationary effects. Sometimes,
however, upward pressures on prices are developing as output and employment are
softening, especially when an adverse supply shock, such as a spike in energy
prices, has occurred. Then, an attempt to restrain inflation pressures would
compound the weakness in the economy, or an attempt to reverse employment losses
would aggravate inflation. In such circumstances, those responsible for monetary
policy face a dilemma and must decide whether to focus on defusing price
pressures or on cushioning the loss of employment and output.
Increasing inflation might get built into decisions about prices and
wages, thereby adding to inflation inertia and making it more difficult to
achieve price stability.
Beyond influencing the level of prices and the level of output in the
near term, the Federal Reserve can contribute to financial stability and better
economic performance by acting to contain financial disruptions and preventing
their spread outside the financial sector. Modern financial systems are highly
complex and interdependent and may be vulnerable to wide scale systemic
disruptions, such as those that can occur during a plunge in stock prices. The
Federal Reserve can enhance the financial system’s resilience to such shocks
through its regulatory policies toward banking institutions and payment systems.
If a threatening disturbance develops, the Federal Reserve can also cushion the
impact on financial markets and the economy by aggressively and visibly
providing liquidity through open market operations or discount window lending.