The standard Federal Reserve (Fed) monetary tools identified in the textbook sti

Question

The standard Federal Reserve (Fed) monetary tools identified in the textbook still are in place, but are currently less effective than they were in the past. This is mostly due to the unprecedented actions the Federal Reserve took after the financial crisis to avoid a Great Depression-like financial meltdown. The result was the Great Recession, although without Fed intervention many economists believe the result could have been far worse. Intervention after the financial crisis was required because the Fed is congressionally mandated through the Federal Reserve Act of 1978 and later amendments to undertake policies directed at maintaining full employment, while keeping the inflation rate under 3% in an environment of stable real economic growth, preferably at an annual rate of over 3%. It is a tough directive that was much easier for the Fed to fulfill when they were able to couple their federal funds rate adjustments with fiscal supply-side policies coming from an environment of high unemployment, slow real economic growth and excessive inflation during the 1970s. In our current environment of low unemployment, low inflation and once again slow real economic growth, it is much more difficult for the Fed to simultaneously prevent an increase in inflation and cool the labor market without risking pushing the real economy back into recession and bringing on price deflation. To many economists, business leaders, laborers and consumers, it is unclear that the Fed should even be undergoing a policy of raising the federal funds rate at this time. None-the-less, the current view of the Board of Governors is that this and all other rates should now be increased. The problem facing the Fed, however, is that the current environment has essentially sterilized the effectiveness of traditional open market operations for targeting the federal funds rate. In the past, when labor market conditions tightened and upward pressure was being made on prices, the FOMC simply engaged in systematic increases in the federal funds rate through strategic open market purchases of Treasury securities (short term Treasury Bills, primarily) to accomplish the twin goal of lowering inflation and labor employment, albeit sometimes with negative fallout with regards to the rate of real economic growth. Before discussing the questions below, please read Monetary Policy 101, an article you will find in the Lecture Notes. Now that you have read the article, what do you think? What is different now? Will raising interest rates today result in the real economy falling back into a recession, thus adversely affecting the labor market and possibly bringing on deflation? …or, from what you have read and learned in this course so far, should we expect the Fed policy as laid out in the article to result in a firm full employment labor market, with the real economy continuing to edge ahead at a small positive rate of increase in a calm environment of low inflation? …or do you feel something else will happen? Why? If the Fed doesn’t act and leaves rates where they are, what would you expect to happen on all three fronts (i.e., with labor unemployment, inflation and real economic growth)? Instead of raising the federal funds rate, maybe the Fed should follow the lead of the Bank of Japan and bring on negative real interest rates? Do you think we need to have negative real interest rates? Why? Finally, do you trust the Fed and our politicians to do anything right? What are they doing right? What are they doing wrong? What is your candid view of the future of the US economy?

Explanation / Answer

The monetary policy before and after the Great Depression changed a lot. there have been bad reforms made by the government which created money crunch for the economy. The raising rate of interest resulted in falling back the economy into recession due to weak structures of policy created by the government. The labor market is adversely affected due to increase in the rate of interest imposed in the market. There has been chances of deflation in the market as well. The policy by Federal Reserve resulted the firm into full employment labour market showing real economy with continuing edge ahead. It shows the environment of low inflation. The Fed doesn’t act and leaves rates where they should expect to happen on all three fonts such as labor unemployment, inflation and real economic growth. The raising of federal fund rates would have followed the lead of the Bank of Japan, It would have brought negative real interest rates. We require negative interest rates so that expenditure is not levied in the economy. The Federal Reserve and politicians are trusted as they are working for the development of the economy and raising the GDP. The future of the US economy shows that there is scope of improvement in technology and trade policies.

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