Glossary
Monetary policy
A central bank's management of interest rates and the money supply to control inflation and support employment.
On this page
Monetary policy is what a central bank does to influence the cost and availability of money and credit in an economy. In the US, the Federal Reserve sets policy to pursue the dual mandate Congress gave it: maximum employment and stable prices, which the Fed defines as 2% inflation over time measured by the PCE price index. Because interest rates feed into borrowing, spending, the dollar and the value of every financial asset, investors watch Fed decisions more closely than almost any other news.
The main tools
- Policy rate: the Federal Open Market Committee (FOMC), meeting eight times a year, sets a target range for the federal funds rate, steered mainly by the interest rate the Fed pays banks on reserves.
- Balance sheet: buying large quantities of Treasuries and mortgage securities (quantitative easing) pushes long-term rates down; letting them run off (quantitative tightening) does the reverse.
- Guidance: statements and projections about the likely path of rates move markets before any change takes effect.
- Lending facilities: the discount window and emergency programs provide liquidity in stress.
Tight and loose
Raising rates or shrinking the balance sheet is tightening, used to cool inflation. Cutting rates or buying assets is easing, used to support growth. Policy works with long and variable lags, often a year or more, so the Fed acts on forecasts. Monetary policy is distinct from fiscal policy, which is government taxing and spending.