Why It Matters: Monetary Policy

Why explain the role of money, banking and monetary policy in an economy?

This is another practical module. Have you ever made a purchase, saved some of your paycheck, or taken out a loan? If so, this module is for you, and you probably know at least some of what the module has to say. If not, it’s time you learned this real life knowledge.

Three photographs of the signs on the Bank of America, TD Bank, and Wells Fargo buildings.

Bank Collage. TDBank, Bank of America, and Wells Fargo by Mike Mozart, CC-BY.


It’s a bit ironic that after all you have studied in this course about buying, selling, producing and consuming, it’s only now that we introduce money and the financial side of the economy. In an important sense, this module is similar to the previous one on budgets and fiscal policy.  In this module, like the last one, we start with practical stuff:

  • What is money?
  • What are banks?
  • How does credit work?
  • What is the difference between a credit card and a debit card?

Then we move to explaining how the government regulates the financial system and uses monetary policy to influence the direction and speed of the economy.

As this is written, interest rates have been unusually low for several years. Some are barely above zero. This is not so good for savers, but it is very good for borrowers.

  • If you are interested in getting a loan to buy a car or getting a mortgage to buy a house, you probably wonder when interest rates will start rising back to “normal,” higher levels.
  • If you are saving for retirement, low interest rates mean you may have to work more years to save up that nest egg, so you also want to know when interest rates will increase again.

After completing this module, you should have a good understanding of how to answer these questions.


  • Define money; Explain the functions of money; Define liquidity
  • Define credit (or debt)
  • Explain what a bank does
  • Understand how money is created by lending
  • Explain the structure, functions and responsibilities of the Federal Reserve System
  • Differentiate between M1 and M2 (measures of the supply of money)
  • Define monetary policy and differentiate it from fiscal policy
  • Define interest rates
  • Explain how the equilibrium interest rate is determined in the market for money.
  • Explain how monetary policy affects GDP and the price level.
  • List and explain the goals of monetary policy.