Effective monetary policy aims to keep inflation low and stable from "summary" of Principles of Macroeconomics by N. Gregory Mankiw
To promote stable prices, the central bank conducts monetary policy. High inflation erodes the value of money, making it difficult for people to accurately judge prices and allocate resources effectively. It also distorts the information that prices typically convey. If prices rise unpredictably, people have a harder time distinguishing whether relative price changes reflect changes in supply and demand conditions or changes in the overall level of prices. Inflation is also costly to individuals and businesses who must frequently adjust prices, wages, and contracts to keep up with changing prices. Keeping inflation low and stable is one of the primary goals of effective monetary policy. To achieve this goal, central banks set short-term interest rates. When the central bank lowers interest rates, it becomes cheaper to borrow money, leading to increased spending on investment goods, housing, and consumer durables. This boost in spending stimulates the economy and pushes up the rate of inflation. Conversely, when the central bank raises interest rates, it becomes more expensive to borrow money, leading to decreased spending on investment goods, housing, and consumer durabl...
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