Question

What are the three major economic goals of monetary policy; discuss how they are interrelated ?

Answer 1

Three major economic goals of monetary policy:

• Maximum sustainable employment
• Stable Prices
• Moderate long-term interest rates.

According to Alban William Philips and his concept of philips curve, in the short run, there is inverse relationship between inflation and unemployment. When inflation which is price levels of goods/services are high, the rate of unemployment will be low which is employment will be high.

When maximum employment is attained, it will increase the price levels of good/services as citizens will be earning more and if they all have money, it will be the case of too many money chasing few goods which is high demand of goods and as we know that when demand is high, price is also high as per law of demand. So, in order to attain maximum employment, the price levels also have to maintained so as inflation does not reach very high, That's why the first goal is maximum "sustainable" employment. Discussing about moderate long-term interest rates, when interest rates are moderate, then only investors will having moderate balance of investment in order to earn more return and liquid funds for daily basis activities. If the interest rates are too high, investors will look to park their funds in depository institutions which will withdraw liquidity from market and when the liquidity is low in market, the aggregate demand for product/services will increase and lead to inflation.