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Knowledge Base

Understanding Monetary Policy with John B. Taylor


What is monetary policy?

Monetary policy is about the management of the money supply in the economy by a central bank. In the United States, that central bank is called the Federal Reserve. Central banks often target interest rates as a way to influence prices, full employment, and stable economic growth.

Central banks can target stable prices through open market operations of buying and selling treasury bonds, paying interest on reserves they hold, setting reserve requirements, or lending money through the discount window.

They often have multiple goals, including managing inflation, reducing unemployment, and promoting moderate long-term interest rates.

What is the Federal Reserve?

The Federal Reserve System, often referred to as the Federal Reserve or simply "the Fed," is the central bank of the United States. It was created by the Congress to provide the nation with a safer, more flexible, and more stable monetary and financial system. 

The Federal Reserve conducts the nation's monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices. It also supervises and regulates banks and other important financial institutions to ensure the safety and soundness of the nation's banking and financial system, and to protect the credit rights of consumers. It maintains the stability of the financial system and provides certain financial services to the U.S. government, U.S. financial institutions, and foreign official institutions.

What is money?

Money is a part of wealth used to facilitate transactions. It is the amount that you have in your wallet that you can use for transactional purposes. Money also is used in different ways in different countries, which makes it even harder to measure. Although some countries use currency frequently, other countries do not.

Money has three functions: as medium of exchange, a unit of account, and a store of value.

A medium of exchange refers to selling something in exchange for money. 

A store of value means the ability to save a portion of its value and exchange or redeem it at a later time. More generally, a store of value is anything that retains purchasing power into the future. 

Finally, a unit of account is the value of something measured in a specific currency, which allows different currencies to be compared against one another. 

What is a rules-based monetary policy?

A rules-based policy is a monetary policy in which a central bank rarely deviates from established norms. It does not make exceptions based upon extenuating circumstances. However, it does provide flexibility for the central bank to adjust to economic developments, but in a predictable way, thereby creating transparency and allowing businesses, families, and workers to long-term economic decisions without worrying about what the central bank might do in the future.


Central Banks- A central bank is a financial institution given privileged control over the production and distribution of money and credit for a nation or a group of nations. The central bank is usually responsible for the formulation of monetary policy and the regulation of member banks.

The Federal Reserve- The Federal Reserve System (FRS) is the central bank of the United States. The Fed, as it is commonly known, regulates the U.S. monetary and financial system. 

The Federal Reserve performs five general functions: conducting the nation's monetary policy, regulating banking institutions, monitoring and protecting the credit rights of consumers, maintaining the stability of the financial system, and providing financial services to the U.S. government. To learn more, click here

Equation of Exchange- The equation of exchange is an economic equation that showcases the relationship between money supply (M), the velocity of money (V), the price level (P), and final output (Y). The formula is expressed as MV= PY.

InflationInflation is the increase in the prices of goods and services over time.