Monetary Policy While the Economy

Monetary Policy

While the economy showed promising growth during February and March of 2005, this trend slowed somewhat later in the year, during spring (Greenspan, 2005). The economy shows a weaker trend during this time, which can also be attributed to the rise in world oil prices and the accordingly rising inflation rate. Other factors playing a role in the weakening economy include slowing employment gains, weakening consumer sentiment and the slowing household and business spending momentum. While crude oil prices are a substantial factor in the weakening economy, the ruling was that the economy was not fundamentally affected, despite the downward trends.

There is nonetheless a higher rate of inflation, according to Greenspan's testimony, as energy and other commodities pressurize both costs and pricing power upwards. This is however balanced by positive trends in other economic areas, such as employment rates. These have been rising, as have retail spending and further trends in oil and natural gas prices. While core consumer price inflation has slowed, labor and product markets have continued their declining trend. In response, the federal funds rate was raised for the purpose of reducing monetary policy accommodation. Favorable aggregate demand depends upon crude oil and natural gas prices. If these stabilize, prospects are good. Ongoing increases in wealth, employment and income combined with low interest rates seem to be expanding. Business investment trends upward in the areas of equipment and software. This is attributed to favorable financial market conditions, and the tendency of technology to age quickly, requiring upgrades or new equipment (Greenspan, 2005).

Furthermore the U.S. dollar seems fairly strong, and thus foreign contributions to U.S. growth are not very high. Overall however economic trends appear to be fairly stable, depending upon future oil and natural gas prices. This would decrease the upward pressure currently showing on the inflation rate. Core inflation is projected to either stabilize or decrease (Greenspan, 2005).

The Federal Reserve does not seem particularly concerned with rises in inflation. It appears that productivity and work issues enjoy greater scrutiny. Together with these however there are also several other issues that enjoy the particular attention of the Reserve.

Inflation trends are projected to hold steady or decline during 2005. Pressure on inflation is relieved by factors such as softening prices of crude materials and intermediate goods, and import prices that have slowed as a result of the global value of the dollar. The economic outlook is therefore favorable, and inflation is not causing a large amount of concern.

There are however a number of uncertainties that could negatively affect the current favorable outlook of the economy. One of these is energy prices. It is not currently clear what the future trend of these will be, as related and causative factors are unstable. If energy prices rise further, it is likely that private spending will be influenced and economic expansion may be negatively affected. The high and volatile prices of crude oil and natural gas appear troublesome for future predictions (Greenspan, 2005).

Another uncertain factor affecting the economy is productivity, which is delineated in unit labor costs, or the hourly labor compensation to output per hour ratio. An increase in productivity over the last decade has favorably influenced the United States' economy, in that efficiency gains restrained inflation. The concern is however that this rapid growth in productivity cannot be maintained. This inherent uncertainty is substantiated by the fact that output per hour, that reached its peak in 2003, seems to be declining. This may result in recession trends, although the duration of the productivity decline is uncertain. A related concern is the sharp decline of output measured from the product side of national accounts, although output as measured from the income side has not slowed as drastically. It is not clear how serious this is for the determination of future recession trends, as more information is necessary to determine this (Greenspan, 2005).

There are several factors influencing current monetary policy. While the general economic trends have been favorable for much of 2005, there are also negative factors such as oil and gas prices, as well as the state of terrorism that have to be considered. Anti-globalization and protectionist initiatives could also pose a threat to the global economy. The flexibility of the American monetary policy is affected by the above initiatives, and would substantially decrease the ability of the United States to absorb shocks in an economically viable way. The flexibility and openness for which the U.S. market is known is attributed largely to the bipartisan effort to reduce regulation and promote openness (Greenspan, 2005).