Economist Talks About How the

¶ … Economist talks about how the Federal Reserve's dual mandate of stabilizing prices and creating maximum employment is becoming less of a mandate and more of a background goal. Much of the criticism relative to the Fed's actions comes on the heels of its most recent quantitative easing campaign last month, dubbed "QE2." This has had the effect of creating more fear about the potential for inflation due to the enlarging of the money supply and calls for financial austerity from both sides of the aisle in Washington DC.

Certainly the Fed's ability to affect financial policy changes has not diminished, but its effectiveness as a mechanism for price controls and maximum employment is questionable in this recession. The article argues that the Fed's behavior has been labeled as "confused, hypocritical or ideologically motivated." (Economist, 2010). This has created much frustration and the Fed has become a favorite target for blame. The Fed has many tools for helping to stabilize prices. One of these tools is through the manipulation of interest rates.

Typically, during a recession, the Fed will lower interest rates to encourage growth through money borrowing and loans. This has occurred as the article points out, but much of the money is not being lent by the banks that are getting it from the Fed at very low interest rates. This has created a condition where liquidity is low and the effective money supply has been diminished. Typically this causes inflation, as the money supply grows and there is more money in the system.

The opposite is true as the Fed raises rates, which will be its main weapon against the potential for massive inflation in the near future. High interest rates encourage people to save money and collect a decent amount on their balances instead of borrowing at high interest rates. Higher interest rates help to kill inflation, but the Fed's quantitative easing has created so much money in the system that it is questionable whether or not it will be able to adequately handle such supply through raising interest rates alone.

This is one of the fears that many people share, and that the Economist article deftly points out. The Fed's argument about keeping interest rates low as a mechanism for job creation has also been rather unproductive. The Fed argues that by offering low interest rates on borrowed money that businesses will take loans to grow. But in this recession, there is no reason to grow when there is decreased demand for goods and services.

One reason for this decreased demand is that the unemployment rate is so high, and people are unwilling to buy things they don't need. Also, as banks shrink available credit, people have less money to spend on credit cards and other instruments of credit. The Fed has also tried to keep interest rates low while fighting what it calls a major threat to economy and jobs stability, which is deflation. Deflation is the lessening of prices as the money supply contracts.

By participating in QE1 and QE2, the Fed argues it has increased the money supply to levels that help to eliminate deflation and encourage pay rates to stay the same. The Economist article explores how from both sides, the Fed is.