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The Eccles Federal Reserve Board Building in Washington, D.C. houses the main
offices of the Board of Governors of the United States' Federal Reserve System
Monetary policy[edit]
Central banks implement a country's chosen monetary policy.
Currency insurance[edit]
At the most basic level, monetary policy involves establishing what
form of currency the country may have, whether a fiat
currency, gold-backed currency (disallowed for countries in
the International Monetary Fund), currency board or a currency
union. When a country has its own national currency, this involves
the issue of some form of standardized currency, which is
essentially a form of promissory note: a promise to exchange the
note for "money" under certain circumstances. Historically, this was
often a promise to exchange the money for precious metals in some
fixed amount. Now, when many currencies are fiat money, the
"promise to pay" consists of the promise to accept that currency to
pay for taxes.
A central bank may use another country's currency either directly in
a currency union, or indirectly on a currency board. In the latter
case, exemplified by the Bulgarian National Bank, Hong
Kong and Latvia, the local currency is backed at a fixed rate by the
central bank's holdings of a foreign currency. Similar to commercial
banks, central banks hold assets (government bonds, foreign
exchange, gold, and other financial assets) and incur liabilities
(currency outstanding). Central banks create money by issuing
interest-free currency notes and selling them to the public
(government) in exchange for interest-bearing assets such as
government bonds. When a central bank wishes to purchase more
bonds than their respective national governments make available,
they may purchase private bonds or assets denominated in foreign
currencies.
The European Central Bank remits its interest income to the central
banks of the member countries of the European Union. The
US Federal Reserve remits all its profits to the U.S. Treasury. This
income, derived from the power to issue currency, is referred to
as seigniorage, and usually belongs to the national government.
The state-sanctioned power to create currency is called the Right of
Issuance. Throughout history there have been disagreements over
this power, since whoever controls the creation of currency controls
the seigniorage income. The expression "monetary policy" may also
refer more narrowly to the interest-rate targets and other active
measures undertaken by the monetary authority.
Goals[edit]
High employment[edit]
Frictional unemployment is the time period between jobs when a
worker is searching for, or transitioning from one job to another.
Unemployment beyond frictional unemployment is classified as
unintended unemployment.
For example, structural unemployment is a form of unemployment
resulting from a mismatch between demand in the labour market
and the skills and locations of the workers seeking employment.
Macroeconomic policy generally aims to reduce unintended
unemployment.
Keynes labeled any jobs that would be created by a rise in wage-
goods (i.e., a decrease in real-wages) as involuntary
unemployment:
Men are involuntarily unemployed if, in the event of a small
rise in the price of wage-goods relatively to the money-wage,
both the aggregate supply of labour willing to work for the
current money-wage and the aggregate demand for it at that
wage would be greater than the existing volume of
employment.
—John Maynard Keynes, The General Theory of Employment,
Interest and Money p11
Price stability[edit]
Inflation is defined either as the devaluation of a currency or
equivalently the rise of prices relative to a currency.
Since inflation lowers real wages, Keynesians view inflation as
the solution to involuntary unemployment. However,
"unanticipated" inflation leads to lender losses as the real
interest rate will be lower than expected. Thus, Keynesian
monetary policy aims for a steady rate of inflation. A
publication from the Austrian School, The Case Against the
Fed, argues that the efforts of the central banks to control
inflation have been counterproductive.
Economic growth[edit]
Economic growth can be enhanced by investment in capital,
such as more or better machinery. A low interest rate implies
that firms can borrow money to invest in their capital stock and
pay less interest for it. Lowering the interest is therefore
considered to encourage economic growth and is often used
to alleviate times of low economic growth. On the other hand,
raising the interest rate is often used in times of high economic
growth as a contra-cyclical device to keep the economy from
overheating and avoid market bubbles.
Policy instruments[edit]
See also: Monetary policy reaction function