General characteristics of approaches to the implementation of monetary policy

Monetary policy is a set of activities that the central bank undertakes for the purpose of maintaining price stability in order to promote sustainable and balanced development of the economy.

The ultimate (main) objective of the monetary policy is to ensure price stability. This is due to the fact that the rates of change in prices in the economy (inflation) are completely determined in the long run by the rate of change in the money supply. In this sense, inflation is a monetary phenomenon. The impact of monetary policy on the long-term growth of the economy is not directly showed, but indirectly through the formation of a favorable price environment for investment activities.

At that, in the short and medium term, monetary policy measures influence the economic activity, and inflation, other than money supply, is affected by other factors. As a result, the impact of monetary policy on inflation is carried not directly, but indirectly through their impact on aggregate demand in the economy and production costs, which determines the functioning of the monetary policy transmission mechanism.

The mechanism of the monetary policy influence on the state of the economy and inflation is quite complex. At the same time, specific features of its work are one of the key criteria for choosing the monetary policy regime of the country – a set of rules and procedures for conducting monetary policy by the central bank.

The key characteristic of the monetary regime is the system of targets forming a kind of hierarchical structure in which, in order to achieve the ultimate goal, it is necessary to consistently put and execute operational and intermediate targets by means of applying appropriate monetary policy instruments.

A common characteristic of intermediate targets is their stable relationship with the ultimate goal, quantitative measurability, the central bank’s ability to influence them with its instruments, as well as transparency and understandability. The use of intermediate targets is necessary because the interrelation between instruments and the monetary policy ultimate objective is complex. Signals sent to the economy through the central bank’s operations and instruments are manifested in the dynamics of the general level of prices with a lag (time lag).

Operational objectives enhance the interrelationship between monetary policy instruments and intermediate targets. By dint of their formulation and achievement, central banks ensure the performance of intermediate and, therefore, ultimate goals. The choice of operational objectives is determined by the monetary policy regime, and the operational objectives themselves predefine the use of specific instruments of monetary policy.

In the world practice, the most common are the following monetary policy regimes:

  • exchange rate targeting;
  • monetary targeting; and
  • inflation targeting.
Regime Operational objective Intermediate objective Ultimate objective
Exchange rate targeting Nominal exchange rate Nominal exchange rate Price stability
Monetary targeting Monetary base / interest rate Monetary aggregate
Inflation targeting Interest rate Inflation forecast

The exchange rate targeting regime means that the central bank pegs the value of the national currency to the exchange rate (basket of currencies) of the country (countries) with a low inflation rate, i.e. an intermediate goal of monetary policy is a certain level of or change in the exchange rate. Based on the theory of relative purchasing power parity, this regime assumes that when fixing the exchange rate, the inflation level within the country should approximate the inflation in the country of the anchor currency. Currency interventions act as the main tool for achieving the monetary policy objectives.

In order to effectively use this regime, the country should have a substantial volume of gold and foreign exchange reserves to counter shocks in the foreign exchange market.

The monetary targeting regime uses one of the money supply indicators as an intermediate target. Theoretically, based on the exchange equation of I. Fisher, this regime presupposes the presence in the country of a close direct relationship between the chosen intermediate target and the consumer price index. The instruments for regulating the banks’ liquidity are the main tool for achieving the monetary policy objectives.

An important condition for the efficient implementation of the monetary targeting regime is the availability of a flexible exchange rate of the national currency against foreign currencies. This allows the central bank to concentrate on solving the tasks of managing the money supply by dint of banks’ liquidity regulation tools, as well as minimize the influence of the currency channel on the intermediate objective.

The inflation targeting regime assumes that the central bank achieves its ultimate objective through managing inflation expectations. The inflation forecast acts as an intermediate goal. The main monetary policy’s impact is carried out, as a rule, through the interest rate channel.

More details on the theoretical and practical aspects of monetary policy regimes can be found in the works of Mironchik and Bezborodova (2015), Luzgin and Godes (2010).


The monetary policy transmission mechanism is a set of channels through which monetary policy impulses affect economic activities and the level of prices in the economy in the short and medium term. In the long-term period, in accordance with the concept of the neutrality of money, monetary regulation does not affect the real economic variables (GDP, interest rate, etc.).

The transmission of a monetary impulse is carried out in three main stages, which causes the presence of a time delay – a lag. At the first stage, the change in the operating instrument of monetary policy affects the variables of the financial sector, prices of non-financial assets and the economic agents’ expectations. At the second stage, the behavior of economic agents is adjusted, which is reflected in the dynamics of consumer and investment activities, as well as foreign trade. At the third stage, the production volume in the country changes, which is reflected in the dynamics of the money supply and domestic prices for goods and services.

The channel of the monetary policy transmission mechanism can be defined as a system of economic relations emerging between sectors of the economy in the course of the consistent transfer of the monetary policy impulse through a specific economic category into the real economy and inflation. Typically, the following channels of the transmission mechanism are defined: interest rate, exchange rate, credit, asset prices and expectations.

More details on the theoretical representation of the monetary transmission can be found in the works of Mironchik (2015), Kharitonchik and Dmitriev (2018).

Long-term economic growth is determined by supply-side factors (structural factors). These include the available technologies, the size and qualification of labor resources, the amount and state of fixed capital, functioning economic institutions, etc. The state is able to influence long-term growth by improving the market system of economy functioning, changing fiscal policy, the mechanism of state regulation of the economy, and not by measures of monetary policy. Stimulation of economic activity by monetary instruments in excess of the potential opportunities of the economic system will inevitably lead to an excessive growth in the money supply, which will have negative inflationary consequences and, as a result, social costs. For more details on the factors of long-term economic growth, see the works of Mironchik and others (2016), Demidenko and Kuznetsov (2012), and Komkov (2011).

In the short and medium term, monetary policy can have a significant impact on economic activity. Adjustment of prices for goods and services in response to the change in monetary policy is not carried out one-step, but with a time delay. This means that as a result of the application of monetary policy, there is a temporary change in the conditions of functioning (for example, the real cost of credit resources) of economic entities, which leads to a change in their investment and saving behavior and, consequently, demand in the economy. For more details, see Mironchik and others (2007).