Monetary Policy & Financial Stability

What is the link between financial stability and monetary policy? 

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The link between monetary policy and financial stability is quite clear. The connection between the two ideas is one that is connected in several aspects of their existence, and thus should be investigated in order to build a stronger understanding of the two ideas. The connection of monetary policy and law may not be obvious but, nonetheless, exists and is prevalent in finance law. This blog aims to explain these ideas to achieve a better understanding for all relating to these topics. While complex, I aim to aid those who read to achieve an understanding so that they may too be able to explain this connection.

Monetary policy is a policy that is implemented by the Federal Reserve System (Fed). The goals of this policy are to sustain and enhance the goals of “maximum employment, stable prices, and moderate long-term interest rates” as is outlined by the Fed. The Fed’s mandate for monetary policy is the dual mandate. In other words, the overarching goal of the dual mandate is to promote maximum employment with minimum inflation. Monetary policy is determined by the Federal Open Market Committee (FOMC) in the United States of America. The FOMC is the committee that determines what maximum employment and minimum inflation is. Congress has authority over the Fed to ensure all policy is correctly implemented. 

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Monetary policy is something that is implemented into the economy by the Fed. Monetary policy controls the “overall demand for goods and services”. When demand slows in relation to the economy's ability to produce, unemployment rises and inflation declines. The FOMC would fix this issue through implementing easing monetary policy to then increase demand and slow. Monetary policy can be used for the opposite situation as well. If demand for service or goods is high then unemployment lowers to dangerous rates and inflation rises. In this case the Fed can normalize levels by implementing tightening monterey policy. In short, monetary policy changes how it presents itself based on the situation present.

Good monetary policy relies on three key factors to ensure it works best it can. The first one is that monetary policy must be “well understood and systematic” as the Fed outlines. Monetary policy must be well understood by the public, in other words the goals of maximum employment and stable pricing must be understood by the public. In order to be “systematic”, those in charge of maintaining monetary policy (ie. policy makers) must respond according to and in obvious ways to economic outlook and changes. Policy makers must also effectively communicate to the public what their plan and actions are as well. This is all in order to allow the public to act accordingly to changes they expect to see in the economy. The second factor is that the central bank should implement monetary policy according to the level of inflation. This means the central bank should stimulate monetary policy when inflation is below levels and restrict when inflation is above the goal. There are exceptions in situations that are unique, however it is a policy maker's duty to communicate what methods will be implemented to return to normal levels. The third and final key factor is changing the policy in a one to one ratio with inflation. If inflation goes up by a percent, so should the policy rate. The same is true for the opposite, if inflation goes down by a percent, the policy will go down a point as well. This is only if the change is not caused by temporary factors. 

Finance stability is about building an overall healthy and stable economy that can survive hard times in 

the United States. What's important to note, as the Fed outlines, is that financial stability is not about keeping the general public and business from making money or encouraging them to make money. Financial stability is more so about keeping the economy stable even when employment drops or inflation rises. Monetary policy is a policy that is intended to maintain financial stability. Monetary policy ensures that the Fed can maintain financial stability and explain how to as well. The overall transparency and rules outlined in monetary policy are all intended to benefit financial stability in the United States economy. 

Sources:

“What is the basic legal framework that determines the conduct of monetary policy?” Federal Reserve, 8 Dec. 2025, https://www.federalreserve.gov/faqs/basic-framework-determines-conduct-monetary-policy.htm.

“Monetary Policy Principles and Practice” Federal Reserve, 8 March. 2018, https://www.federalreserve.gov/faqs/basic-framework-determines-conduct-monetary-policy.htm.

“What is financial stability?” Federal Reserve, 8 March. 2018, https://www.federalreserve.gov/faqs/what-is-financial-stability.htm.