What Is the Relationship Between Monetary Policy and Interest Rates?

The intermediate goal of monetary policy refers to the goal that the central bank can achieve with a certain degree of accuracy within a certain period of time and under certain special economic conditions, between the ultimate goal of monetary policy and the operational goal [1].

Intermediate target of monetary policy

Right!

The intermediate goal of monetary policy refers to the goal that the central bank can achieve with a certain degree of accuracy within a certain period of time and under certain special economic conditions, between the ultimate goal of monetary policy and the operational goal [1].

The main reasons for choosing the intermediate goals of monetary policy are:

1. Intermediate goals should be measurable. On the one hand, the central bank can quickly obtain accurate data on these indicators; on the other hand, these indicators must be clearly defined and convenient

In different countries, the intermediate goals of monetary policy have different characteristics.

1. Interest rates. Interest rate is an important indicator that affects the supply and demand of money in society and regulates the total supply of money in the market. Interest rates are highly correlated with the goals of monetary policy. When the economy develops prosperity or inflation, the market interest rate tends to rise; conversely, when the economy declines or deflation, the interest rate shows a downward trend. The central bank can observe the trend of interest rates at any time and indirectly adjust market interest rates.

2. Base currency. The base currency refers to the sum of cash in circulation and the reserve of commercial banks, which is highly controllable, because cash is directly held by the central bank, and the reserve of commercial banks is adjusted by the central bank through the statutory deposit reserve ratio. By controlling the base currency, the central bank can adjust the asset structure of commercial banks and the public and change the total amount of social money supply, which affects interest rates, prices, and overall social and economic activities. Generally speaking, if the base currency is reduced, the problem of money supply in society will be reduced, and the total social demand will be reduced accordingly. Conversely, if the base currency is increased, the problem of money supply in the society will also increase, and the total social demand will increase.

3. Money supply. The money supply is an intermediate target commonly adopted by central banks in various countries. Each level of the money supply can be controlled by the central bank to varying degrees. The increase and decrease of the money supply affects economic growth, price stability, and employment goals. Therefore, the correlation between the money supply and monetary policy goals is strong.