The Federal Reserve Monetary Policy

The Federal Reserve (FED) is the central bank of the United States. One of its purposes is to set interest rates at which banks lend each other money and another interest rate by which banks borrow money directly from the Fed ("How Interest Rates Work."). The interest rates set by the Fed affect the borrowing, the lending, and by extension the economy of the country. Any changes in the interest rates at which banks borrow money from the Fed will influence the country’s economy. Thus, the higher the interest rate, the lower loans are demanded. Consequently, due to this mechanism, the lower the interest rates, the higher the growth of the economy ("How Interest Rates Work."). When the Fed goes down interest rates, banks can borrow money for less.

The discussion of whether the Federal Reserve should raise the federal funds rate is a highly contentious one. Members of the Federal Reserve (“Fed”) and academic economists disagree about what constitutes appropriate future macroeconomic policy for the Unites States. In the past, the Fed had been able to raise rates when the unemployment rate was under 5% and inflation was at a target of 2%. Enigmatically, since the Great Recession and despite a strengthening economy, year-over-year total inflation since 2008 has averaged only 1.4%—as measured by the Personal Consumption Expenditures Price Index (“PCE”). Today, PCE inflation is at 1-1.5% and has continuously undershot the Fed’s inflation target of 2% three years in a row. (Evan 2015) In the six years since the bottom of the Great Recession the U.S. economy has made great strides in lowering the published unemployment rate from about 10% back down to about 5.5%. In light of this data, certain individuals believe that the Federal Reserve should move to increase the federal funds rate in 2015 because unemployment is near 5% and inflation should bounce back on its own (Derby 2015). However, this recommendation is misguided.

Monetary policy has to be forward looking in order to allow the market to form expectations accordingly. Hence, it was appropriate in September to start gradual increases in the federal funds rates in order to exit gracefully from the prolonged accommodative trend. Quick increases in rates at a later date will present a higher risk for economic recession. Seeing limitations in monetary policy, the President suggested turning to “policies that encourage investments in technology and human capital, tax and regulatory changes, and longer-run fiscal

Central banks using contractionary monetary policy have many tools to help reduce inflation. Most commonly it is selling securities and raising interest rates through open market operations. Avoiding a recession and lowering unemployment is undertaken by expansionary momentary policy, interest rates are lowered, securities from member banks are purchased and other ways are used to increase the liquidity. “The Fed uses three main instruments in regulating the money supply: open-market operations, the discount rate, and reserve requirements. The first is by far the most important. By buying or selling government securities (usually bonds), the Fed—or a central bank—affects the money supply and interest rates.”

Finally, the process of normalization has begun, and seven years of zero interest rate cycle came to an end in December 2015 with a hike of 25 basis point by the Federal Open Market Committee. It was a much anticipated move for a while, and now the debate is on the roadmap of future interest rate hikes. Several economist, analyst, and media personalities have expressed a variety of opinion on both ends of the rate hike. Should the Fed continue to raise interest rates now, is the question of global consideration. In my opinion, Fed should continue to raise interest rate now to help the economy grow more independently and build up consumer confidence.

The federal reserve has raised interest rates five times in less then twelve months, and the pervious raises are just barely beginning to take effect. The previous raises averaged around a quarter percentage point, and since these raises failed to slow the economy, Greenspan, unable to take anymore chances doubled the previous with a promise of more to come.

The Federal Reserve went into action in response to the 2008 recession by rapidly reducing interest rates with the hopes of encouraging economic growth. The federal funds target rate was decreased to between zero and .25 percent. The results of the rate changes caused what is called “zero bound”, this reduced the effectiveness of monetary policy with the near non-existence of interest rates.

Given its mandate to maximize employment and maintain price stability, the Fed took monetary policy actions in December 2008 to keep long-term interest rates at near zero (between 0.0% and 0.25%) to help stabilize and revive the U.S economy -- leaving no option for further interest rate reduction.

On March 15, 2017, the Federal Reserve raised benchmark interest rates to a range between .75 and 1 percent, a move that markets did not expect until later this year. The stock market is flourishing, employment and wages are increasing, and many feel hopeful that the economy is improving. But the Fed raised rates to “prevent the United States economy from overheating”, writes Applebaum. While Trump plans to stimulate

The Federal Reserve is adjusting to what some call the “new normal.” After the most recent recession the United States has experiences a slow recovery which has a notable disconnect between inflation and unemployment. Further, banks hold high excess reserves and the Fed has a balance sheet which includes over $1.7 trillion in mortgage backed securities (Quarterly, 2017, p.4). As such the Fed has had to rethink its past procedures in order to maintain its dual mandate of maintaining unemployment and price levels. While it has been a decade since this recession began the economy is just now showing signs of strength and such the Fed is beginning a process of “normalization.” To do this the Fed’s has changed its stance on monetary policy in

The Federal Reserves concerns are many; because of the economic diversity of our country. In November 2002, the fed reduced the targeted federal funds rate 50 basis points, to 1.25 percent. The policy easing allowed the Committee to return to an assessment that the risks to its goals were balanced. The Fed has inflation expectations well contained, and the additional monetary stimulus seemed to offer worthwhile insurance against the threat of persistent economic weakness and substantial declines in inflation from already low levels.

The opinions of FOMC members about the economy were generally optimistic about the future of the U.S economy. However, they were reluctant to increase the federal interest rates, citing that the economy is not exactly a sunny picture, except for the labour market (Ashworth, 2015). For instance, although they predicted moderate growth in the overall economy, the growth in household spending is not growing. This could lead to decreased economic growth and increased inflation

The Fed is expanding the money supply. The Fed have data that shows a positive increase in the labor market, house hold spending, housing sector. The Fed is trying to increase price stability, strengthen the labor market, and expand economic activity within the nation. Their policy in place is to reduce inflation.

The FED can only pursue one target at any given time. For example, if they are targeting interest rates, exchange rates will fluctuate and vice versa. The FED’s influence over real interest rates is weaker than that of nominal interest rates and stabilizing the economy is more important than stabilizing interest rates.

One of the most consistent defenses against deflation is for a central bank to target an inflation rate greater than zero. The Federal Reserve’s current inflation target is 2% and has informally been at that rate for quite some time. This nonzero target provides a cushion for policymakers: should inflation decrease due to an unexpected shock to aggregate demand, prices should not immediately start falling. This allows policymakers to act with easy money when inflation reaches 1 or 0%, thus avoiding deflation. Yet, during the last two recessions in the United States, the 2% inflation rate did not prevent significant fear of deflation. Extraordinary action was required, and many economists argue that the low interest rate policy following the 2001-2002 recession contributed to the housing bubble that was inflating at that time. It is not yet known what the impact will be from the unorthodox policies taken in response to deflation fears in 2009-2010. Based on these experiences, it may be time to consider alternative inflation targets to provide greater insulation from deflationary pressures.