- As mentioned briefly before, monetary policy aims to achieve several macroeconomic objectives that contribute to a stable and prosperous economy, including:
- Low and stable inflation
- Low unemployment
- Reducing business cycle fluctuations
- Promoting a stable environment for long-term growth
- Achieving external balance
Low and Stable Inflation
Inflation Targeting
Definition
Inflation Targeting
A strategy where central banks set a specific inflation rate as their primary goal and adjust monetary policies respectively to meet the goal.
The Bank of England targets an inflation rate of 2%. If inflation rises above this target, the bank may increase interest rates to reduce spending and bring inflation back to the target level.
Inflation targeting has become an important aspect for central banks, as:
- It brings stability to the economic environment of the country, allowing investors and consumers to be more confident in their economic decision making.
- Provides a better coordination of fiscal policy with monetary policy, as the set inflation rate goal allows governments to better plan its fiscal policy to work well with the monetary policy.
However, inflation targeting has disadvantages as well.
By focusing solely on controlling inflation, central banks might be forced to adopt policies, such as:
- Raising interest rates, which could negatively affect other parts of the economy by:
- increasing unemployment
- slowing down economic growth
Why is Low Inflation Important?
- Price Stability: Stable prices prevent the decrease of purchasing power.
- Economic Confidence: Predictable inflation encourages investment and consumption.
- Avoiding Hyperinflation: High inflation can lead to economic instability and loss of confidence in the currency.
Low Unemployment
- Monetary policy can help reduce the cyclical unemployment by stimulating economic activity.
- Lower Interest Rates: Reduce borrowing costs for businesses and consumers.
- Due to this, firms are incentivised to invest in new projects, creating jobs.
