EC103-Topic #6: Federal Reserve and the Economy

When the U.S. Federal Reserve conducts monetary policy, they chase both growth in real output and low and stable inflation. However, many other central banks specifically target inflation rather than both inflation and output. Ben Bernanke, Chairman of the FOMC, recently announced that the Fed is attempting to provide more transparency (another link on transparency) to their actions and focus more specifically on inflation targeting. The Wall Street Journal blog puts together several predictions regarding what will likely happen to interest rates over the course of the next several months. If the central bank is attempting to keep inflation low, it should take one course of action, and if the central bank is attempting to prevent a recession, it should take another course of action. In any case, these actions appear to be having very real impacts on the prices of oil, gold, food, and trade.

(Added 11/29)
Yesterday (11/28), the New York Times reported that the Federal Reserve was leaning towards cutting rates at their 12/11 meeting. Read this article to get a better understanding of how important the FOMC is at controlling the economy.

Questions you might try to answer:

  • Are the possible Fed actions currently at odds with one another and handcuffing the central bank? If so, do you think the Fed is changing it’s policy now regarding targeting?
  • Do you believe that inflation or output growth is more important to the overall economy if one can be sacrificed for another?
  • If the Fed continues to fight possible inflation, what do you expect the Fed to do? If they fight inflation, what do you expect to happen to the prices of commodities like oil and gold?
  • Do you believe that the Fed’s recent actions have allowed for the narrowing of the trade deficit and possibly led to easing of inflationary pressures through increased demand for exports? Is there any evidence of this?

Remember… I would like your statements to be as subjective as possible, or in jargon terms, positive and not normative in nature. Also, remember, I want you to keep your descriptions short, basic, and related to classroom content. Read other students comments before posting, and please leave your name with your posting.

19 thoughts on “EC103-Topic #6: Federal Reserve and the Economy”

  1. The American engine seems to be sputtering. The economy hasn’t “tanked” but there are multiple problems that make me jittery. There is still a significant fallout from this summer’s securities fiasco. Just today, I read that Citibank secured an infusion of 7.5 billion in capital from the prince of Dubai in order to remain competitive. Furthermore, one of the assigned articles noted how the American dollar is decreasing in comparison to multiple currencies and gold is up.From my perspective, these are all signals that there is still trouble as well as a lack of confidence, in the American economy. Therefore I believe that the fed should focus on curbing inflation, at the expense of growth. Going after inflation first, will allow you to stabilize everything, attract foreign investment and then begin on restructuring growth. If you focus on growth and inflation spirals out of control, the whole system might collapse.What the Fed needs to realize is that this little spurt over the summer rippled across the globe, even in Asia, a growing market many investors have found secure and extremely profitable. Therefore, easing the trade deficit isn’t going to help. Restoring confidence in the price stability American economy will.As Prof. Neveu said in class, a recession is a chance for the market to re-align itself, something that was avoided with the steep interest rate cuts by Alan Greenspan in 2001. Many believe those cuts caused the current housing boom and recent fallout, both in dramatic fashion. Unfortunately It seems that the fed is cutting interest rates again. Mommy B is spoiling Wallstreet investors with as much milk to suck on as they desire.(http://www.nytimes.com/2007/11/28/business/28cnd-econ.html?hp)While I don’t agree with the cuts, I’m glad that we are fully aware of them. This new level of transparency seems like an ideal way for the Fed Reserve to receive thought provoking criticisms. Maybe they’ll listen.P.S. I’m calling gold at $1,350 by next summer.

  2. If the Fed fights the price of inflation, it will cause the dollar to appreciate in value, allowing the dollar to have more buying power. This will, in theory, make commodities such as gold and oil not as expensive to purchase. The Fed is trying to fight possible inflation by targeting the inflation rate three years in advance, which should produce stability and make the central bank have credibility (Inflation Targeting Lite). Since interest rates and inflation are inversely related, the Fed will have to adjust interest rates in the opposite direction they want inflation to go. Since the most optimistic inflation rate by any member of the Board of Governors is only 2.6% growth, “the inflation is going to be lower three years from now than a forecast that did not condition on the assumption of such Fed behavior would have anticipated” (Analysis of current economic conditions and policy). If the Fed is serious about this, they will have to increase interest rates to lower inflation, and this will make commodities cost less than they have. -Michael Goldsmith

  3. Recession at the current state should be more of a concern to U.S. The inflation in U.S. has been on the rise for the last one year or two. But as of now, recession has even greater social and economical implication than anything else. The FOMC’s main weapon in taming inflation lies in its power to adjust the federal fund rate. If the Fed choose to raise the rate again (which I pray to God they won’t), housing market will drop even further. That will lead to a decrease in household’s wealth – which, in turn, with slowing down consuming of goods and services in U.S. In addition, as the interest rate on the rise, people won’t be able to pay their mortgages, leading to an increase of housing foreclosure. Not only that leads to adverse conditions for many loaning intuitions, but it also has negative impact on investors’ psychology (investors held the belief that the FED will always bail out the market). With regard to commodities such as oil or gold, such commodities, by nature, are quite cyclical in pricing; their prices depend to a substantial degree to the psychology of investors. Right now, people are rushing to gold and bonds, as a mean to achieve a safe investment, backing away from the stock market. As soon as the FED put in its commitment to turn back the economic (which, by Zeus, seem to be heading for recession right now). The stock market will bounce back; dollars will regain its value (this actually will drive down inflation by making imported goods cheaper).

  4. The US economy’s growth is decelerating while the increase in price of commodities and energy gives inflation pressure. Fed’s increasing transparency shows its determination to prepare the public for its inflation targeting in order for their policy to achieve its goal. The Fed choose to target a lower inflation rate, this will stabilize the economy and prevent the increase in commodity price and energy price from reducing consumption even more in the economy. If inflation is not control, the price of getting these commodities with US dollar will increase dramatically by adding on to the (already) increasing real price in these commodities (due to global/real factor, tensions between country may alter oil supply/price). This will eventually plunge the economy deeper into a recession. So preventing inflation should be touched before preventing the recession. This will hopefully keep the current consumption rate. Fed’s recent action will increase net export because if interest rate fall, dollar will be depreciate. But there is a worldwide pressure of inflation, thus net export will only have a modest effect on US economy’s status. JunZHu

  5. I agree with Andrew. The Fed should be focusing on the inflation rate rather than on economic growth. The US economy can afford to take a small hit to its growth for the sake of not causing a recession right? Since the American dollar value is decreasing, it only seems logical to try to bring it back up again rather than letting it fall so far that foreign trade would be severely crippled. I believe that the purchasing power of the US dollar should be the primary concern. Since the price of gold and oil are rising, it would make sense to try to keep up. If an interest rate hike is necessary then so be it. Ben Forman

  6. The Federal Government is indeed at odds due to the fact that the dollar is becoming weaker compared to other currencies. They should change their policy regarding targeting due to a possibility of a recession. The rate of inflation is crucial to the economy due to its effect on the dollar. To balance out the economy, the FED must keep the interest rates low; however, this will affect the value of the dollar. Moreover, this will lower our currency and foreign investment into the United States. They must increase interest rates in order to lower inflation levels; oil and gold prices will be lowered. The FED has been on the right track by lowering interest rates because in the end, the trade deficit will improve as demand for exports increase.- Trevor Brucato

  7. If the Fed continues to fight inflation, the value of money might increase. To do so, the Fed might reduce the amount of money supply circulating in the market. To reduce money supply requires the Fed to raise reserve requirements, sell previously purchased U.S securities, and raise the discount rate. Thus, price of commodities such as gold and oil become less expensive as consumers feel that their dollars are worth more in value. Also as the Fed become more transparent with their monetary policy making, people would be more aware of the changes in inflation rate (Fuller). This will enable investors to make better prediction and investment which will help improve the economy.

  8. Fed uses monetary policy as an important way to stabilize an economy; however, inaccurate time or misunderstanding of public may cause a recession or highly inflation in the economy. Therefore, Fed is attempting to be more transparency to the public. It provides that “the forecasts will look three years into the future, rather than the current two years, and will include considerable detail about range of views among policy makers.” The transparency will help individuals or market make decisions on their investment properly. Right now, from price of oil, gold and exchange rate of euros, we can see a decrease in the purchasing value of dollar and a light inflation in economy. Therefore, I do not think it is a right time to cut the interest rate again because it causes a deeper depreciation of dollar, capital outflow and higher inflation.

  9. The Fed has taken action to fight potential inflation by increasing the amount of information given to U.S. Citizens. Chairman Ben Bernanke recently made changes in our economic policy so that now, four times a year, the Fed will announce their economic projections for the next three years. This is an important step in preventing inflation because the American public will be more equipped to anticipate target inflation rates; such preparation will, in turn, keep our economic situation relatively predictable and our consumption constant. Keeping inflation rates low adds worth to our currency, and also technically lowers the price of commodities such as oil and gold. I expect that this openness will keep our economy more or less stable, and if the central bank continues to disclose their predictions for the coming years, our dollar will gain value. If the Fed does not keep the inflation rate under control, we will inevitable fall into a recession because pricing of oil and gold are already on the rise as it is now. In the past couple of months, the purchasing value of the dollar has actually decreased, and oil and gold are as expensive as ever: “Gold is up 24% and oil 34% since the beginning of September, while the dollar has only slid 7%. The price of gold and oil has gone up substantially for everybody in the world, regardless of the currency used to buy them” (Econbrowser). This means that it will be a significant challenge for the Fed to strengthen our economy, but it must be done so that we can reduce the prices of oil and gold and keep our economic growth secure.

  10. If the Fed fights inflation, they have to increase the interest rate or reduce the money supply. This will lead to activity reductions in the Loanable Funds Market. Firms and potential borrowers tend to borrow less and reduce their investment. Also it leads to a decrease in consumption as well as output. Meanwhile, the mortgage crisis hasn’t been resolve yet, and the housing market continues to decline as housing foreclosures continues to increase. If the Fed fights inflation, it makes it harder for the owners to refinancing their home. What I think the Fed should do at this moment is not to fight inflation. They should focus on the mortgage crisis, and try to help investors and home owners regain their confident in the housing market. Once the housing market slowly recovers, investors and banks will gain their confident in investments.

  11. By announcing that it will reveal more information about growth and inflation, the Federal Reserve intends on making the economy more stable in the long run. Although there will be no “inflation target” announcements, the Fed will double the economic forecasts in a year, forecast an additional year into the future, and include greater detail in the forecasts, which will give people in US markets more certainty in the future of the economy. This allows for real incomes and real interest rates to remain more stable in the long run, despite changes in nominal incomes and interest rates. A problem with revealing more about expectations and plans for policy-making is that it could limit the Fed from taking swift action when unexpected events shake the economy, which is why Alan Greenspan opposes “inflation targeting”. Donald L. Kohn’s recent insinuation of a possible rate cut taking place on December 11th and the immediate effect it has had on the Dow Jones shows the powerful effect of anticipated policy-making.

  12. There is an inverse correlation between commodity prices and the value of American currency, as demonstrated by the performance of gold relative to the dollar thus far in 2007. Inflation is therefore responsible for the increased cost of commodities to American consumers and must be controlled in order to avoid the economic consequences that would derive from it.The FED has a limited amount of tools at its disposal to fight inflation by contracting the current money supply. Continuing to combat this threat would require the use of open market operations and increasing real-interest rates. Doing so would stabilize the value of the dollar, and also decrease commodity prices.Increasing interest rates, by discouraging inventory build-up, also discourages speculation on commodities and makes government bonds a more appealing investment. Selling off government bonds decreases the money supply by creating additional opportunities for public investment in securities to meet current market demands. This takes away demand for investment in commodities such and gold and oil, and thus lowers their price.

  13. The stability of an economy in its central macro economics’ pillars, growth, employment and prices, is crucially dependent upon the control of its monetary policy, the control of money supply to achieve macroeconomics goals. The monetary policy is controlled in many countries, US for instance, by the Federal Reserve Bank, also called the Central Bank, which conducts strategies to guarantee that the country’s growth output, level of employment and level of the prices are stable to meet the country’s demands. Thereby, since the circulation of money can create inflation, one of the Central Bank’s main goals is to combat inflation, by regulating and monitoring the supply of money in circulation, though its three main ways such as the increasing the reserve deposit in banks, purchasing and selling government securities and regulating the interest rate at which it loans funds to commercial banks. Those many supply tools are suitable to hold the stability of prices, however due to political reasons, decision-makers may choose to nominee a Federal chairman who is more likely to undertake a more expansionary economy, in spite of the independence of the Fed, making the economy in some situations, surpasses the importance of growth and the prices.

  14. Information concerning new interest rate policy has recently been disclosed by Federal Reserve Chair Donald L. Kohn, stating that in the upcoming December 11th meeting conducted by the Federal Reserve, there will be a proposed cut on interest rates. This will cause a considerable change in the economic policy, as the central bank in the United States is promoting an increase in spending, yielding greater output. Contrarily, there will be a rise in the level of inflation, causing commodities such as gold to be of greater monetary value. However, it is believed that this inevitable jump in inflation is just a small price to pay for a very necessary increase in economic growth. Real estate has suffered greatly due to this lack in spending, as sales have fallen, and inventories have only risen. The rise in inventory of housing and other goods is attributed to a decrease in demand, which will be redirected if the revision in monetary policy next month provides a cut in interest rates. Many are skeptical that another rate cut will weaken our economy by increasing inflation to a level that is unhealthy, but in the current state it is imperative that we see an economic boost, which can only be brought on by lower interest rates that will reignite spending that has declined significantly in recent months. Combating inflation is something that needs to be addressed, but at a later date; increasing economic growth is crucial at this moment.

  15. The government needs to focus on controlling inflation before concentrating efforts in output growth. If the govt lets the value of the dollar grow any weaker, we will lose possible investment from other countries. In addition, the value of our economy will begin to become compromised compared to those same countries. The value of the dollar was once much higher in comparison to that of Canada, for example. If the govt focuses too much on growth, it is likely that inflation may grow out of control and it will be harder to remedy than if it is solved right now. Therefore, once the American currency is once again secure and stable the govt can then focus on growth.

  16. I agree with Andrew and Ben that a stronger dollar is necessary to restore faith in the economy and avoid a recession. Transparency will help keep inflation low. While the growth rate of GDP is important, it can not come at the expense of a weak dollar. The Federal Reserve Chairman Ben Bernake’s has implemented a new initiative to publish economic projections four times a year predicting economic output and inflation over the next three years. Recent predictions that the rise in GDP will be below average and inflation will be kept low, show the importance of a strong dollar. However, a strong dollar does have some negative consequences. Exports and tourism are really benefiting from the weak dollar in comparison to foreign currencies. Transparency is important because swift movement often produces uncertainty in the economy as the public often sees through the Fed’s actions anyway. As Erica pointed out, gold and oil prices are increasing throughout the world because of political conflicts in Iraq and Iran. However, the impact of such political upheaval would not have as great of an impact with a stronger dollar. -MA

  17. Even though the US dollar has recently hit record breaking lows, I believe that the Fed should focus more on GDP growth. As Chi and Jonah both stated, the economy going into a recession is a more immediate threat than growing inflation. Raising rates would definitely help fight inflation. However, it would most likely also drastically hurt GDP growth. With the new level of transparency put in place, we can focus more on GDP growth than inflation. Though inflation may continue to stay high, transparency will allow people to prepare for it and act accordingly. The transparency put in place will help people avoid serious problems with inflation, without hurting GDP growth.

  18. The fed should be keeping an eye on inflation rather than economic growth. The U.S. has enough production capacity that it can afford a bit of growth in order to avoid a recession. If the fed attempts to fight inflation, they will most likely lower interest rates. The fed must keep interest rates low, however this will effect the dollar. If we do not take care of inflation, it will lower the value of our currency as well as foreign investment into the U.S. Inflation should be our number one concern to avoid the possible recession that is to come.

  19. The Federal Reserve does seem to be contradicting itself on what to do about inflation and also interest rates. On one side of the argument is that interest rates need to be lower so that banks will lend and more investments will be made. On the other side they are worried about inflation rates and the lowering value of the dollar. What seems to be the most important right now, though, is to try and regain our superiority over seas and increase our dollar value by controlling inflation. Too much growth with prices going out of control is really not as easily maintained anyway. If goods are very expensive, especially food, gold and oil, people will have a hard time affording them or investing their money in anything besides them. Lowering interest rates more will only be showing bad lenders and borrowers that it is ok to consistently make bad investments and we need a change in our policies and borrowing and lending strategies. Lowering rates will also make the U.S. a less attractive place to invest money into and to hold capital because their money wont be worth as much. But if inflation gets too out of hand any time soon, it will be much harder for the Fed to decrease them than it will be to maintain them now and restructure our economic policies before it is too late.Katie Swartwood

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