• Promoting Balanced Economic Growth
• Combating Inflation

The Fed is best known for its role in making and carrying out the country’s monetary policy—that is, for influencing money and credit conditions in the economy in order to promote the goals of high employment, sustainable growth, and stable prices.

Goals of Monetary Policy
Sustainable growth
High employment
Stable prices

The long-term goal of the Fed’s monetary policy is to ensure that money and credit grow sufficiently to encourage non-inflationary economic expansion.

The Fed cannot guarantee that our economy will grow at a healthy pace, or that everyone will have a job. The attainment of these goals depends on the decisions of millions of people around the country. Decisions regarding how much to spend and how much to save, how much to invest in acquiring skills and education, how much to spend on new plant and equipment, or how many hours a week to work may be some of them.

What the Fed can do, is create an environment that is conducive to healthy economic growth. It does so by pursuing a goal of price stability—that is, by trying to prevent inflation from becoming a problem.

A stable level of prices is most conducive to maximum sustained output and employment. Also, stable prices encourage saving and, indirectly, capital formation because it prevents the erosion of asset values by unanticipated inflation.

Inflation causes many distortions in the market. Inflation:

• hurts people with fixed income—when prices rise consumers cannot buy as much as they could previously
• discourages savings
• reduces economic growth because the economy needs a certain level of savings to finance investments that boost economic growth
• makes it harder for businesses to plan—it is difficult to decide how much to produce, because businesses can’t predict the demand for their product at the higher prices they will have to charge in order to cover their costs

Inflation is sustained by excess money and credit in the economy. Money refers to cash in circulation, plus the amounts that people and businesses have in bank accounts. Credit refers to amounts that banks and other lenders can lend.

Inflation will result if money and credit rise too rapidly compared with the ability of the economy to produce goods and services. And it will enable sellers to raise prices. However, the growth of money and credit should not be too slow, or people and businesses will not be able to get loans they need for major purchases that stimulate the economy.

The Fed has to maintain an appropriate pace for the growth of money and credit—one that will produce sustainable economic growth and price stability. The Fed has a number of tools to do this job.

September 2007