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Role of Monetary Policy on the Economy

Monetary policy includes all actions taken by the central bank to manage supply of
money in an economy. The Federal Reserve is the institution in charge of monetary policy in the
USA. It uses interest rates variations, control of the amount of government bonds that are held by
banks, and bank reserve requirements to achieve policy objectives.
Goals of monetary policy and its ties to the economy
The Federal Reserve’s monetary policy has two main objectives. These are control of
inflation and reduction of unemployment. The core inflation rate that the Federal Reserve seeks
to maintain is 2% (Johnson, 2017). When inflation rises beyond this figure, the Federal Reserve
increases interest rates. Higher interest rates increase cost of borrowing thus reducing money
supply in the economy. When inflation is below 2% it lowers interest rates in order to increase
money supply in the economy.
A secondary goal of the Federal Reserve’s monetary policy is to reduce unemployment
through promotion of economic growth. To speed up economic growth, the Federal Reserve uses
expansionary monetary policy (low interest rate) which increases liquidity thus stimulating
economic activities in the country (Johnson, 2017). The Federal Reserve’s monetary policy,
therefore, has a direct impact on the economy.
Chronological life cycle of monetary policy
The monetary policy of the Federal Reserve usually reflects inflation levels and economic
performance as the monetary policy measures of the past six economic quarters reveal. On 20 th
December, 2018, the Federal Reserve set interest rate at 2.25%. Since then, it progressively

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reduced the rate until it reached 0% on 16 th March, 2020 (Board of Governors of the Federal
Reserve System, 2020). The progressive reduction of interest rates in the past six quarters
reflects the economic situation of the same period. Slowing economic growth has necessitated
progressive reduction in interest rate in order to energize economic activities and create
economic growth.
Integration of applicable social and legal frameworks
The Federal Reserve’s conduct of America’s monetary policy is governed by legal
framework established by the US Congress. This framework provides the economic objectives
that the Federal Reserve should pursue, it sets up structures that give it operational independence,
and mechanisms that are meant to guarantee appropriate levels of accountability and
transparency (Board of Governors of the Federal Reserve System, 2020). In addition to this legal
framework, the Federal Reserve also faces social accountability from various social forums
which has an effect on the policy measures that it takes. These forums include independent
media, professional peers, academics, and interest groups.
Connection between advantages and disadvantages of entitlements
The Federal Reserve’s monetary policy has an effect on various entitlements, particularly
unemployment benefits. When interest rate is low, there is more economic growth and more
employment thus fewer unemployment benefits claims. Conversely, high interest rates dampen
economic growth and lead to more unemployment benefits claims.
Summary

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The use of monetary policy is one way in which government intervenes in the economy.
It is, however, not the most effective policy because it takes time for its effects to be felt. While
it is easy to implement, it also has major technical limitations. For instance, the Federal Reserve
cannot reduce interest rate below 0%. Thus, when there is a recession and low inflation, there is
little that the Federal Reserve can do to bring the economy back to health. To make monetary
policies more effective, it is important that they be implemented together with fiscal policies
designed to bring about the same result. The Federal Reserve should also be strictly independent
to prevent other institutions such as the presidency from influencing its decisions.

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References

Board of Governors of the Federal Reserve System (2020).. What is the basic legal framework
that determines the conduct of monetary policy? Retrieved on 28 th March, 2020 from
https://www.federalreserve.gov/faqs/basic-framework-determines-conduct-monetary-
policy.htm
Board of Governors of the Federal Reserve System (2020). Federal Open Market Committee.
Retrieved on 28 th March, 2020 from
https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
Johnson, H. G. (2017). Introduction: Macroeconomics and Monetary Theory.
In Macroeconomics and Monetary Theory (pp. 1-4). Routledge.