Kenneth R. Szulczyk
to break down. Banks link savers to the investors. Thus, the whole economy would need
restructuring, and another financial institution would evolve into something similar to a bank
that would lend to businesses and households.
Monetary Policy Goals.........................................................................
Goal of monetary policy is to increase the well-being of society. Economists measure well-
being in terms of the quantity and quality of goods and services that people consume. The Fed
has six monetary policy goals, which are:
Price stability: Product prices communicate information to households and businesses.
Households determine how many goods to buy while businesses determine how many goods to
produce. Inflation is a continual increase in prices of goods, and services, and it erodes the value
of money. Furthermore, a high inflation rate becomes more variable, thus, creating uncertainty
for businesses, consumers, and workers. The uncertainty leads to adverse effects on decisions
and hinders economic growth. If the inflation rate soars, then money’s functions of a “store of
value” and “medium of exchange” breaks down.
High employment: The Federal Reserve and the federal government reduce unemployment
as much as possible because massive unemployment causes human misery. As workers remain
idle, factory space and equipment become underutilized. When a society does not use all its
resources, an economy’s GDP grows at a slow rate or even decreases. Government cannot
reduce the unemployment rate to zero. In some cases, unemployment occurs when workers quit
their jobs and look for new ones, or students graduate and enter the labor market. The Fed tries
to lower the unemployment rate to the natural rate of unemployment. Currently, economists
estimate the natural rate of unemployment to be 6% for the United States. If the Fed strives for
an unemployment rate below 6%, then the Fed’s policy creates inflation.
Economic growth: A growing economy has an increasing real GDP because society
produces more goods and services. A high real GDP growth rate lowers the unemployment rate
while businesses earn profits. Then they raise their investment, producing more goods and
services. Furthermore, strong economic growth causes increasing incomes for businesses and
households. When businesses and households have higher incomes, the local, state, and federal
governments collect more tax revenues. Thus, the Fed uses monetary policy to spur strong
economic growth.
Financial market and institution stability: Financial panics, bank runs, stock market
crashes, or bankruptcies of large financial institutions could trigger a chain reaction that causes
other financial institutions to bankrupt. Unfortunately, a financial panic disrupts the link
between savers and investors. Then businesses do not receive loans they need to invest while
customers do not receive loans to buy homes, cars, and other assets. If the financial markets and
institutions break down, then the economy can enter a severe recession, causing high
unemployment and slow or negative GDP growth rates. Consequently, the Fed stabilizes the
financial system by being a “lender of the last resort,” preventing financial panics.
Interest rate stability: The Fed stabilizes the interest rates because fluctuating interest rates
create uncertainty in the economy, and businesses, and households experience difficulties
planning for the future. Businesses become uncertain about investing in new buildings,