Glossary · Money and central banks
Monetary policy
Monetary policy is what a central bank does with interest rates and the supply of money to keep inflation low and the economy steady.
Also called: tight money, loose money, easy money, hawkish and dovish
Federal funds rate, November 9, 2026
Consumer prices to Sep 2026
The “real” key rate, with inflation to Sep 2026
In plain words
Think of a thermostat. When the room gets too hot it turns on the cooling; when it gets too cold, the heating. A central bank does the same for the economy, and the temperature it watches is inflation. What it does with its controls is called monetary policy.
When prices rise too fast, the central bank tightens: it raises its key interest rate, loans get dearer, people and companies borrow and spend less, and prices calm down. When the economy slumps and jobs vanish, it loosens: it cuts rates so borrowing gets cheaper and spending picks up.
The catch is time. A rate change takes a year or more to work through the economy, so central banks act on forecasts, a bit like steering a big ship that turns slowly.
Example
Tightening, step by step
- Inflation runs at 6% against a 2% goal. The central bank raises its key rate from 1% to 5% over a year.
- Mortgage rates climb too. A family planning a $300,000, 30-year mortgage would have paid $1,347 a month at 3.5%; at 7% it is $1,996. They buy a cheaper home, or wait.
- A company drops plans for a factory it would have financed at 8%; shops hold back price rises because fewer customers come in.
- A year or two later inflation is back near 2%, usually with somewhat higher unemployment along the way.
Loosening is the same film run backward: cheaper loans, more spending, more jobs, and, if overdone, inflation again.
One level deeper
The tools: the key rate (the main one); open market operations, buying or selling government bonds to add or drain money; quantitative easing and quantitative tightening when rates are near zero; forward guidance, promises about future rates that move long-term rates today; and, less and less, rules on how much cash banks must hold.
Monetary policy is not fiscal policy. Fiscal policy is the government taxing and spending; monetary policy is the central bank managing money and rates. The two can push in the same direction or pull against each other.
A rough gauge is the key rate minus inflation, the real key rate. In the US it is +0.2% (the fed funds rate minus inflation over the 12 months to Sep 2026). Well above zero usually means tight money; below zero means that, after inflation, borrowing costs next to nothing.
The Fed’s rate and inflation since 1954
Look for the pattern: inflation rises and the rate follows it up; a recession hits (shaded) and the rate comes down fast. In the 1970s the rate often stayed below inflation and prices kept speeding up. In 1980–81 the Fed pushed it far above inflation, and inflation broke.
The numbers behind the chart
| Date | Federal funds rate | Inflation (CPI, 12 months) |
|---|---|---|
| Jul 1954 | 0.8% | 0.3% |
| Dec 1960 | 2.0% | 1.4% |
| Dec 1970 | 4.9% | 5.6% |
| Dec 1980 | 18.9% | 12.3% |
| Dec 1990 | 7.3% | 6.3% |
| Dec 2000 | 6.4% | 3.4% |
| Dec 2010 | 0.2% | 1.4% |
| Dec 2020 | 0.1% | 1.3% |
| Dec 2022 | 4.1% | 6.4% |
| Dec 2023 | 5.3% | 3.3% |
| Dec 2024 | 4.5% | 2.9% |
| Dec 2025 | 3.7% | 2.7% |
| Nov 2026 | 3.9% | — |
Why it matters
It decides how much your savings earn and your loans cost, and through them how much house or car a paycheck can buy.
Done well, it keeps inflation low without needless recessions; done badly, it can cause both, as in the 1970s and early 1980s.
Markets hang on every word: a change in what central bankers say about future rates can move stock and bond prices as much as the rate itself.
A common mistake
Questions people ask
What is the difference between tight and loose monetary policy?
Tight (also called contractionary or hawkish) policy means high interest rates and slower money growth, to bring inflation down. Loose (expansionary, dovish) policy means low rates and more money, to support jobs and growth.
Who makes monetary policy?
The central bank: in the US the Federal Reserve’s FOMC, in the euro area the ECB’s Governing Council, in the UK the Bank of England’s Monetary Policy Committee. In most rich countries the government sets the goal but not the rate.
How long does monetary policy take to work?
Months to years. The biggest effect on spending often comes a year or more after a rate change, and on inflation later still; Milton Friedman called the delays “long and variable”.
Read more on BigCapital
About the numbers
- The numbers on this page are recalculated from the data every night; the sources are listed at the end of the page.
- US recessions (NBER business cycle dates): National Bureau of Economic Research (NBER), Business Cycle Dating Committee: US Business Cycle Expansions and Contractions.
- Effective federal funds rate: Board of Governors of the Federal Reserve System, H.15 Selected Interest Rates, series H15/H15/RIFSPFF_N.D (Federal funds effective rate), Data Download Program. The EFFR is subject to the Terms of Use posted at newyorkfed.org. The New York Fed is not responsible for publication of the EFFR by BigCapital, does not sanction or endorse any particular republication, and has no liability for your use.
- Consumer price index, all items (CPI-U): U.S. Bureau of Labor Statistics, Consumer Price Index, series CPIAUCSL; retrieved from FRED, Federal Reserve Bank of St. Louis.
- The mortgage payments in the example are standard fixed-rate arithmetic (monthly payments over 30 years), before taxes and insurance.
- This page explains a term. It is not investment advice.