In this section of the course the formulation and implementation of monetary pol

Question

In this section of the course the formulation and implementation of monetary policy is discussed. One of the main issues of monetary policy is that of the appropriate target and indictor of monetary policy. There are two main targets of monetary policy I want you to concern yourself with the interest rate target and the inflation target. The Federal Reserve has been targeting interest rates, most notably the federal funds rate, to guide monetary policy. However, many believe the Fed should target inflation. What target do you think the Fed should aim at interest rates or inflation rates? Please explain why.

Explanation / Answer

Fed should target interest rate because it affects output. Lower interest rate encourages people to borrow more and demand increases. To meet the demand, production of output takes place and GDP increases. It further gives boost to the other macroeconomic indicators such as employment and disposable income.
As a result of increased production activities and the positive economic scenario, inflation also increases. At this point of time, Fed should take initiatives to control the inflation. Thus, the first objective of Fed is to boost the economy and in the next step, Fed controls the inflation to bring in price stability in the economy.

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