Monetary Policy and the Economy Using the tools of monetary policy, the Federal Reserve can affect the volume of money and credit and their price "interest rates. In this way, it influences employment, output, and the general level of prices. a a a a a a a a a a a a a a a THE FEDERAL RESERVE ACT LAYS OUT the goals of monetary policy. It specifies that, in conducting monetary policy, the Federal Reserve System and the Federal Open Market Committee should seek "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."" GOALS OF MONETARY POLICY Many analysts believe that the central bank should focus primarily on achieving price stability. A stable level of prices appears to be the condition most conducive to maximum sustained output and employment and to moderate long-term interest rates; in such circumstances, the prices of goods, materials, and services are undistorted by inflation and thus can serve as clearer signals and guides for the efficient allocation of resources. Also, a background of stable prices is thought to encourage saving and, indirectly, capital formation because it prevents the erosion of asset values by unanticipated inflation. However, policymakers must consider the long- and short-term effects of achieving any one goal. For example, in the long run, price stability complements efforts to achieve maximum output and employment; but in the short run, some tension can arise between efforts to reduce inflation and efforts to maximize employment and output. At times, the economy is faced with adverse supply shocks, such as a bad agricultural harvest or a disruption in the supply of oil, which put upward pressure on prices and downward pressure on output and employment. In these circum-stances, makers of monetary policy must decide the extent to which they should focus on defusing price pressures or on cushioning the loss of output and employment.
