Monetary Policy and the Economy

According to the Treaty on European Union, which has defined the fundamental objectives and tasks of the Eurosystem, the primary objective of the Eurosystem is to maintain price stability. Moreover, without prejudice to the objective of price stability, the Eurosystem is charged with supporting the general economic policies in the Community (such as sustained, noninflationary growth). 

In the short term, the changes in money market rates initiated by changes in a central bank’s key rates trigger numerous mechanisms and prompt reactions by market participants that ultimately influence the development of economic variables such as production and prices. This process, which is referred to as the monetary policy transmission mechanism, is complex, and although we are familiar with the basic underlying principles, the evidence that is available on all the relevant aspects is inconclusive and mixed. 

Nevertheless, experts largely agree that in the long run – after all economic adjustments have fully come to bear – changes in interest rates applied to monetary policy operations will, ceteris paribus, change the general price level but have no sustained impact on other real variables, such as real output or unemployment.  Ultimately, a change in the money supply represents a change in the unit of account (and hence the general price level), as all other variables are not affected; by analogy, if the standard measure of distance is changed (from kilometers to miles, for example), the distance between two places remains the same.

A central bank which maintains price stability makes a substantial contribution to the achievement of broader economic goals, such as higher standards of living, high levels of economic activity and better employment prospects. By ensuring price stability, a central bank also supports more general economic goals.