Formulating Economic Policies

How is monetary policy determined?

To understand how a policy is formulated, you have to first understand the motivation of the Central Bank. Depending on the country we are referring to, the central bank either is independent of or controlled by the government. Regardless, in general it is safe to assume that the Central Bank wants to achieve its mandate. For the Federal Reserve in the US, it is maximum employment (5.2% to 5.5%), stable prices (2% inflation), and moderate long-term interest rates; for the Bank of England, it is similar, it has the dual mandate of maintaining financial stability and meeting the government’s inflation target, which is at 2%; for the Monetary Authority of Singapore, it aims to promote sustained non-inflationary economic growth, a sound and progressive financial centre using the exchange rate as a main policy instrument. The key economic principle here is that agents respond to incentives, and agents are rational. The Central Bank’s staff is incentivised to achieve the bank’s objectives and will find ways to do so actively.

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