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. Insights

    How Monetary Policy Affects Your Investments

    Monetary policy changes can have a significant impact on every asset class. investors can position their portfolios to benefit from policy changes and boost returns by being aware of the nuances ...
  2. Insights

    How Much Influence Does The Fed Have?

    Find out how current financial policies may affect your portfolio's future returns.
  3. Insights

    Fiscal Vs. Monetary Policy Pros & Cons

    When it comes to influencing macroeconomic outcomes, governments have typically relied on one of two primary courses of action: monetary policy and fiscal policy.
  4. Insights

    Not Crazy: Unconventional Monetary Policy

    Unconventional monetary policy, such as quantitative easing, can be used to jump-start economic growth and spur demand.
  5. Trading

    Monetary Policy

    Monetary policy is a central bank’s actions that influence the country’s money supply and the overall economy.
  6. Insights

    The Top 6 Ways Governments Fight Deflation

    Here are six monetary and fiscal policy tools that governments use to fight deflation.
  7. Insights

    The Importance Of Inflation And GDP

    Learn the underlying theories behind these concepts and what they can mean for your portfolio.
  8. Investing

    What Causes Inflation in the United States

    Inflation is the main catalyst behind U.S monetary policy. But what causes this phenomenon of sustained rising prices? Read on to find out.
  9. Insights

    Open Market Operations vs. Quantitative Easing

    How does the Fed's implementation of Quantitative Easing differ from its more conventional open market operations?
  10. Financial Advisor

    Breaking Down the Federal Reserve's Dual Mandate

    The Fed has been tasked with a dual mandate by Congress to achieve monetary stability. We explain what the dual mandate is and what it means.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center