Macroeconomics - Monetary Policy and Price Level Stability

Stable Prices vs. Sustainable Growth in real GDP
Price level stability refers to the concept that price levels are stable enough so that people do not feel compelled to take inflation into account when making economic decisions. Many economists believe that measured inflation in the range of 0 up to 2 or 3 percent a year is actually zero inflation. There may be quality improvements in goods that are not reflected in the official measurement of inflation; this reflects a price level measurement bias.

Price level stability is only a means to a higher goal. That goal is a rising standard of living, which depends upon sustainable growth in real GDP. Whether or not that growth is sustainable depends upon other factors such as technological advances, availability of natural resources, the willingness of people to work, the willingness of people to invest, and political stability. Monetary policy helps to create a stable environment which favors investment and saving.

Achieving Price Level Stability
The Federal Reserve can quickly affect short-term interest rates, such as three-month T-bills and rates on savings deposits. However, the impact of monetary policy on longer-term interest rates is more moderate and more difficult to predict. Longer-term interest rates are more influenced by the supply and demand for investment funds, as opposed to monetary factors. Secondly, the impact of inflation must be taken into account. For example, suppose an expansionary monetary policy is perceived to be inflationary. The impact of that policy on longer-term interest rates, such as real estate mortgages, will be to raise them.

Expansionary Monetary Policy
An expansionary monetary policy, if inflationary effects are not anticipated, should lower interest rates, particularly short-term ones. It will also have the effect of reducing velocity, as the opportunity cost of holding money is reduced. Eventually the lower interest rates will induce more personal and business spending to occur so that aggregate demand will increase. This process could take several quarters. Eventually the increased demand will cause nominal and real interest rates to go higher, which will increase the velocity of money. At that point the impact of the expansionary monetary policy will be further amplified.

Expectations of Monetary Policy
Related Articles
  1. Personal Finance

    Invest in Costco? First Understand Its Balance Sheet

    A strong balance sheet sets a company apart and boosts investor confidence. How healthy is Costco based on an analysis of its balance sheets from the last two years?
  2. Investing Basics

    Brokers and RIAs: One and the Same?

    Brokers and registered investment advisors have some key differences. Here's what you need to know.
  3. Professionals

    DCF Vs. Comparables: Which One To Use

    DCF and Comparables models are widely used in equity valuation. We explain the pros and cons of each method.
  4. Professionals

    How To Make Money Using Tobin's Q Ratio

    Although it seems simple, Tobin's Q Ratio is more complex than it appears. We explore some of its main strengths and weaknesses.
  5. Taxes

    3 Secrets You Didn't Know About Estate Planning

    Every advisor and saver needs to know these three estate planning secrets.
  6. Professionals

    Cash Flow Is King: How to Keep it Running

    Why is cash flow so important, and what steps can a business take to improve it?
  7. Entrepreneurship

    10 Ways to Nurse Cash Flow in Healthcare

    Running a business in healthcare? You might want to rethink cash flow management practices.
  8. Professionals

    How to Help Clients with Cash Flow Issues

    Sometimes your spending gets out of hand or income has a hiccup. Here's how financial advisors can help clients who have cash flow issues.
  9. Professionals

    How to Improve Your Cash Flow in Manufacturing

    Here are 10 ways to to improve a manufacturer's cash flow.
  10. Professionals

    10 Ways to Improve Cash Flow in Construction

    Improving cash flow in construction requires some sector-specific strategies.
RELATED TERMS
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  4. Security Analyst

    A financial professional who studies various industries and companies, ...
RELATED FAQS
  1. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  2. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
  3. What types of positions might a Chartered Financial Analyst (CFA) hold?

    The types of positions that a Chartered Financial Analyst (CFA) is likely to hold include any position that deals with large ... Read Full Answer >>
  4. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  5. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ... Read Full Answer >>
  6. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!