Federal Reserve Bank Is the Term Paper

  • Length: 7 pages
  • Sources: 7
  • Subject: Economics
  • Type: Term Paper
  • Paper: #65871462

Excerpt from Term Paper :

It is also worth noting that the Fed must understand how the relationship between its actions and the outcomes changes under different circumstances. For example, open market transactions put more money into the economy; they do not imply that spending will increase. Thus, more money in the economy will not necessarily lead to more growth, lower unemployment or higher inflation, even though the typical relationship is that they will.

The third part of the Fed's mandate is with respect to unemployment. The Fed notes that the central tendency of the unemployment rate in the U.S. is between 5.2% and 6.0%. This is basically the target range that the Fed has for unemployment The Fed only has the ability to influence employment. The employment issue is fairly complex, and there are a number of different variables. Monetary policy instruments are somewhat minor variables compared with some fiscal and trade policy instruments, so the Fed can only work within a range, rather than focusing on one specific target unemployment number.

The Fed typically will influence the unemployment rate by focusing on fostering the conditions for economic growth. By creating the conditions for higher economic growth, the Fed can contribute to a climate that drives down the unemployment rate. Generally speaking actions both in terms of open market operations and the discount rate that either increases the amount of money in the economy or the cost of money will spur economic growth. Ideally, economic growth -- in particular growth in business investment -- should help bring down the unemployment rate.

Recent Performance

The recent economic conditions and Fed action highlights the challenges that the Fed faces in trying to manage the economy. When the economy began to slide badly in 2008, it was accompanied by a credit crunch, so banks were not lending. This stifled business investment. Consumer spending was already off from 2006 levels because investment in real estate -- or spending fueled by borrowing against real estate assets -- was also down. The Federal Reserve responded with fast, aggressive monetary policy, dropping the discount rates to near zero, and engaging in expansionary open market transactions.

These monetary policy tools, which are normally effective for handling slight declines in economic performance, were inadequate for the depth of the slump that was faced. Banks had surplus capital, but were reluctant to lend it, and business investment remained suppressed in response to the sluggish consumer spending. Thus, unemployment not only rose quickly but with slow responses to this expansionary polices, unemployment has only fallen slowly. Moreover, because business investment and consumer spending remain at relatively low levels for this intensity of expansionary monetary policy, inflation has remained low as well.

The recent experience highlights the overall effect that the Federal Reserve can have on the economy. Monetary policy tools in general have an impact mainly under normal conditions. The economy responds to changes in monetary policy strategy and the Fed in that way is capable of effectively managing the economy. However, when the economic shock is strong, the Fed may not have sufficient tools to address it. Runaway growth can be addressed by raising interest rates very high, but a deep slump puts the Fed against the zero bound for interest rates, such that the Fed cannot alone bring about recovery. The Fed has done all it can -- even undertaking risky actions -- in the past few years, but without adequate fiscal policy or trade policy, the Fed under these circumstances can only have a limited effect on the economy, at best stabilizing it but not being able to spur strong economic recovery.

Works Cited:

Bernanke, B. & Kuttner, K. (2005). What explains the stock market's reaction to Federal Reserve policy? The Journal of Finance. Vol. 60 (3) 1221-1257.

Federal Reserve. (2013). Statement on longer-run goals and monetary policy strategy. Federal Reserve.gov. Retrieved April 19, 2013 from http://www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf

Federal Reserve Education.org. (2013). Monetary policy basics Federal Reserve. Retrieved April 19, 2013 from http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy/

Federal Reserve Education.org. (2013). The structure of the Federal Reserve system. Federal Reserve. Retrieved April 19, 2013 from http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/

Gagnon, J., Raskin, M., Remache, J. & Sack, B. (2010). Large scale asset purchases by the Federal Reserve: Did they work? Federal Reserve Bank of New York. Staff Report No. 441.

Romer, C. & Romer, D. (1996) Federal Reserve private information and the behavior of interest rates. NBER Working Paper 5692.

The Economist. (2013). The other side of QE. The Economist. Retrieved April 19, 2013 from…

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