The Importance of Monetary Policy

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Monetary policy is important in decisions the United States government makes about economic practices and regulations, but equally important are the fiscal policies, which government spending and tax reform are geared toward in stimulating the economy.

To understand the importance of monetary policy in the equation, one must first understand what the term means. The Economic Times defines monetary policy as "the macroeconomic policy laid down by the central bank," which manages interest rates, money supply, and functions as the demand side of economic policy to affect inflation, consumption, growth, and liquidity.

There is, however, a limit to the amount monetary policy can affect the economy because it hinges upon interest rates and monetary circulation. Once the interest rate hits zero, there's not much more the Federal Reserve can do in terms of monetary policy to help the economy.

Fighting Inflation Versus Fighting Unemployment

The U.S. Department of State argues that one of the key reasons that monetary policy is favorable during financially successful periods of the American economy is that it affects inflation rates positively but is relatively useless in fighting unemployment. 

This is because there's a limit to the amount of monetary manipulation the Federal Reserve can do to the global value, or exchange rate, if the U.S. dollar plummets. Monetary policy primarily affects interest rates through control of the amount of currency in circulation (and other factors), so when the interest rate bottoms out at zero percent, there's nothing else a bank can do.

If you take a look back at the Great Depression, over 3,000 banks failed during the 1930s—monetary policy meant very little when the value of the dollar had sunk to its lowest rate in history. Instead, fiscal policy and a series of unpopular yet successful economic policies helped America get back on its feet.

Fiscal policy opened up new jobs and increased government spending to right the wrong of the market crash. Basically, the United States—or any governing body—can, in times of need, enact aggressive fiscal policy to combat market stagnation.

How Monetary Policy Applies Now

Because the United States economy has experienced its highest point in the last decade (the 2010s), monetary policy that cuts taxes and increased government spending in business and job-creation markets, especially under former President Barack Obama, has led to a decrease in the unemployment rate and a rapid increase in the United States' GDP.

Fiscal and monetary policies go hand in hand in the federal legislature, where annual budgets dictate government spending in certain economy-stimulating areas as well as the creation of jobs through social welfare initiatives. The Federal Reserve annually dictates interest rates, liquidity, and currency circulation, which in turn also stimulate the market.

In truth, without either fiscal or monetary policy in United States federal—and indeed local and state—government, the delicate balance of our economy might slip back into another Great Depression. Regulations, therefore, are important to maintaining a status quo across all states wherein each citizen is guaranteed their rights to life, liberty, and the pursuit of happiness.

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Moffatt, Mike. "The Importance of Monetary Policy." ThoughtCo, Sep. 8, 2021, Moffatt, Mike. (2021, September 8). The Importance of Monetary Policy. Retrieved from Moffatt, Mike. "The Importance of Monetary Policy." ThoughtCo. (accessed May 31, 2023).