Contemporary Finance

17Monetary Policy

Monetary policy aims to control inflation and the value of money, or at broader macroeconomic outcomes, by using interest rate and money supply tools to a greater or lesser extent under central bank control. Monetary policy is intertwined closely with regulatory policy and government finance, and overlaps with fiscal policy, the use of public spending as a macroeconomic tool.

Monetary policy techniques became fairly standard in modern times, but in recent decades, new tools have responded to the global financial crisis and to the unusually and persistently low level of interest rates. Financial markets and ideas about how interest rates and money affect the economy have also been evolving. To understand current approaches to monetary policy, it’s important to review those that were in place in the “normal times” before the crisis.

17.1 The Emergence of Monetary Policy

Central banks have primary responsibility for monetary policy and are involved in policies affecting financial stability, management of foreign exchange reserves, maintaining payment systems, and regulation and supervision of intermediaries and markets. The extent of these responsibilities has varied across jurisdictions and through history.

Central banks are old institutions. There is a long history of Italian and Dutch merchant cities creating semi-public banks to facilitate credit and foreign exchange markets. Among the earliest nation-state central banks are the Sverige Riksbank, founded ...