Monetary Policy and the Fed

Read this chapter to understand in more detail the monetary policy tools, process, and impacts on the U.S. economy. Review specific monetary policies and their effects from our recent history.

Problems and Controversies of Monetary Policy

Learning Objectives

  1. Explain the three kinds of lags that can influence the effectiveness of monetary policy.
  2. Identify the macroeconomic targets at which the Fed can aim in managing the economy, and discuss the difficulties inherent in using each of them as a target.
  3. Discuss how each of the following influences a central bank's ability to achieve its desired macroeconomic outcomes: political pressures, the degree of impact on the economy (including the situation of a liquidity trap), and the rational expectations hypothesis.


The Fed has some obvious advantages in its conduct of monetary policy. The two policy-making bodies, the Board of Governors and the Federal Open Market Committee (FOMC), are small and largely independent from other political institutions. These bodies can thus reach decisions quickly and implement them immediately. Their relative independence from the political process, together with the fact that they meet in secret, allows them to operate outside the glare of publicity that might otherwise be focused on bodies that wield such enormous power.

Despite the apparent ease with which the Fed can conduct monetary policy, it still faces difficulties in its efforts to stabilize the economy. We examine some of the problems and uncertainties associated with monetary policy in this section.