Thursday, August 6, 2009

ultimate objectives of monetary policy

ultimate objectives of monetary policy, that the Federal reserve most strongly pursues when it formulate its monetary policies.
Achieving high and stable output levels
One key goal of the Fed is to lay the best monetary policy foundation for the nation to attain high and stable levels of production of goods and services. A nation that produces more output per person than other nations is often assumed more likely to have happier and more productive citizens. A nation that can achieve higher and more stable growth in its production of real output also has better foundation for long-run prosperity for its citizens.
The economy‘s aggregate production function indicates that if real output is high, labor unemployment rates are low, holding other factors unchanged. For this reason, an ultimate aim by The Federal Reserve to attain high and stable growth of real output essentially is the same as a goal to achieve low and stable unemployment rates.
Maintaining low inflation and stable prices
the second fundamental goal of the Fed is to achieve low and stable inflation rates. High inflation, in the absence of fully indexed nominal contracts, imposes a variety of potential costs on individuals, firms, and financial institutions. For one thing , greater inflation encourages individuals and firms to find ways to economize on their holdings of currency and demand deposits , which entails expenditures of real resources. It also entails more frequent price changes and associated menu costs . individuals and firms may also be induced to change the terms of wage and other contracts much more frequently, which is costly in time and effort, or to index contracts to inflation to a larger extent, which also may entail resources costs.
Unanticipated inflation also has redistribution effects, because it effectively transfers wealth from creditors to debtors. Another possible redistribution effect arises if income taxes are not fully indexed, because inflation increases nominal incomes and thereby pushes people and firms into higher tax brackets, effectively raising their taxes without any actual income tax rate increases. to the extent that individuals and firms seek to avoid such redistribution effects, they also incur direct real costs.
Finally, inflation variability also may be costly, because it forces economic agents to determine whether aggregate or relative prices have changed, thereby complicating consumption and production decisions.

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