Monetary policy of the USA
The Federal Reserve implements monetary policy by manipulating the money supply.
Money Aggregates
There are different kinds of money in the economy. The main categories are
- M1: Currency, Traveler's checks, Demand Deposits (checking accounts)
- M2: M1 + small Savings deposits, Money market mutual funds
- M3: M2 + Large deposits, inflation.
Criticism of monetary policy
Some free market economists, especially those belonging to the Austrian School criticise the very idea of monetary policy, believing that it distorts investment. In the free market interest rates will be set by saver's time preference. If there is a high time preference this means that savers will have a strong preference for consuming goods now rather than saving for them. Thus interest rates will rise due to the low supply of savings. With low time preference interest rates will fall. The interest rates send signals to businessmen as to what is worth investing in, low interest rates will mean that more capital is invested.
Monetary policy means that the interest rates no longer represent consumer time preferences and so investments are made by businessmen with the wrong signals. Lower than market interest rates will therefore mean a higher investment than the economy desires. This will mean that there will be capital goods that have been over invested, and will need to be liquidated. This liquidation is the cause of the depression that makes for the business cycle.
See also
