Types of Monetary Policy
In practice, to implement any type of monetary policy the main tool used is modifying the amount of base money in circulation. The monetary authority does this by buying or selling financial assets (usually government obligations). These open market operations change either the amount of money or its liquidity (if less liquid forms of money are bought or sold). The multiplier effect of fractional reserve banking amplifies the effects of these actions.
Constant market transactions by the monetary authority modify the supply of currency and this impacts other market variables such as short term interest rates and the exchange rate.
The distinction between the various types of monetary policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals.
| Monetary Policy: | Target Market Variable: | Long Term Objective: |
|---|---|---|
| Inflation Targeting | Interest rate on overnight debt | A given rate of change in the CPI |
| Price Level Targeting | Interest rate on overnight debt | A specific CPI number |
| Monetary Aggregates | The growth in money supply | A given rate of change in the CPI |
| Fixed Exchange Rate | The spot price of the currency | The spot price of the currency |
| Gold Standard | The spot price of gold | Low inflation as measured by the gold price |
| Mixed Policy | Usually interest rates | Usually unemployment + CPI change |
The different types of policy are also called monetary regimes, in parallel to exchange rate regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results in a relatively fixed regime towards the currency of other countries on the gold standard and a floating regime towards those that are not. Targeting inflation, the price level or other monetary aggregates implies floating exchange rate unless the management of the relevant foreign currencies is tracking exactly the same variables (such as a harmonized consumer price index).
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