Why Does Countercyclical Monetary Policy Matter?

Satyajit Chatterjee

Vice President and Economist

Q2 2001

Business Review — Modern capitalistic economies use stabilization policies to minimize fluctuations in the unemployment and inflation rates. In the United States, the Federal Open Market Committee (FOMC) lowers the target interest rate for interbank loans as economic activity slows or when a financial crisis looms (as in the fall of 1998) and raises it when inflation threatens to accelerate (as in late 1999 and early 2000).

Such countercyclical monetary policy is one example of a stabilization policy. Other examples of U.S. stabilization policies include the federal insurance of bank deposits (and the concomitant supervision and regulation of banking) and income-maintenance programs, such as unemployment insurance.

Macroeconomists have devoted much effort to understanding how countercyclical monetary policy affects the volatility of the unemployment and inflation rates. In contrast, macroeconomists have directed much less effort to understanding why countercyclical monetary policy is beneficial. This neglect reflects the fact that, until recently, macroeconomists of very different persuasions agreed that policies aimed at reducing the volatility of unemployment and inflation are desirable. Of course, economists disagreed about what form those policies should take, but no one questioned the premise that a less volatile macroeconomic environment was a desirable policy goal.

This article appeared in the Second Quarter 2001 edition of Business Review.

View the Full Article