The emphasis the Fed puts on controlling the money supply grows out of its responsibility for keeping the U. S. economy healthy.
The economy is in good shape when:
Inflation is under control, which means prices are stable
The economy is growing
People are working
Long-term interest rates are moderate
The financial markets are strong
The dollar is neither too strong nor too weak against other currencies
Ideally, these elements work in harmony — everyone who wants to work has a job, inflation is minimal, the economy is expanding, long-term interest rates stay fairly constant, and so on. But in reality conflicts often emerge.
Full employment may result in higher wages, which increases inflation. High inflation makes prices unpredictable and may undermine the financial markets. Yet clamping down on inflation often results in an economic slowdown, weakening the financial markets.
These recurrent cycles, when the economy grows, slows, grows again, and slows again, are normal. What the Fed wants to ensure is that neither growth nor decline gets out of hand. Its primary tool is changing the money supply by increasing or decreasing short-term interest rates.
