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What is Monetary Policy?

One of the objectives that the Constitutional Organic Law entrusts to the Central Bank is “to ensure the stability of the currency”. In practice, this means that the Bank must prevent the devaluation of the currency due to inflation. Thus, it is interpreted as an objective of price stability. The set of actions taken by the Central Bank to meet this objective is called Monetary Policy.

What is the Monetary Policy Rate?

The Monetary Policy Rate is the main operational instrument of monetary policy. The Board of the Central Bank discusses and sets the level of this interest rate at its Monetary Policy Meetings, and communicates a trajectory that achieves the inflation goal over two-year terms. In practice, the Monetary Policy Rate determines the level of the daily interbank lending rate, and is implemented through open market operations.

Why Is Inflation Targeting Important?

To fulfill the objective of price stability, the Bank has set as its explicit target that the forecasted inflation remain at 3% over 2-year periods. Low and stable inflation contributes in several ways to greater economic growth. Above all, because this reduces uncertainty and therefore encourages investment and consumption, thus enabling more efficient resource allocation. In addition, keeping inflation low and stable benefits the poor, since they struggle the most in protecting themselves from increases in inflation.

What Is a Floating Exchange Rate?

The Bank applies a floating exchange rate regime, in which the exchange rate is determined by the market, according to the supply and demand for currencies, which enables the implementation of an independent monetary policy. The main advantages of a floating exchange rate regime are to facilitate the adjustment of the economy to real shocks, to prevent steep misalignments in the exchange rate (excessive rises or falls), to avoid a more costly adjustment in terms of product variability and, in principle, to reduce speculative capital movements.