Recent Direction of Monetary Policy Essay Example

unemployment rate was at 4 ? percent (Bernanke).

The FRB Report further states that: “Although real gross domestic product appears to have expanded at about the same average rate thus far this year as it did in the second half of 2006, the pace of expansion has been uneven” (Monetary Policy Report 5). Consumer spending and business fixed investment posted moderate gains but residential construction experienced contraction which exerted significant restraint on the economy (Monetary Policy Report 5). There were also downtrends in other sectors of the economy – particularly in inventory investment; defense spending, and in net exports (Monetary Policy Report 7).Also interesting to read about fiscal policy questions and answers. But the biggest sector to be hit was the housing industry.

Before the recent adoption of stable interest rates, there was a long series of rate increases that the Federal Reserve adopted. These rate increases led to numerous foreclosures as consumers were unable to continue their obligations due to higher amortization levels – which greatly affected the general interest in the housing sector. Thomas Hoenig, President and CEO of the Federal Reserves Bank of Kansas City noted in his speech on the National Economy and Monetary Policy in 2007 that “…past increases in interest rates have slowed housing activity”.Hoenig further states that “The slowing in the housing market has direct and indirect effects on the economy.

Less home construction means fewer jobs for construction workers and fewer building materials purchase” (7). Overall inflation was boosted by sizable increases in food and energy prices. Inflation ran at an annual rate of 4. 4 percent as measured by changes

in the price index for personal consumption expenditures – which, the Federal Reserve points out, would be inconsistent with the objective of price stability (Monetary Policy Report 20).Given these conditions, the Committee decided to leave its target for the federal funds rate unchanged at 5-1/4 percent. The Committee further stated in its policy statement that some inflation risks remained and that additional action would depend on changes in the outlook for both inflation and economic growth.

According to Janet L. Yellen, President and Chief Executive Officer of the Federal Reserve Bank of San Francisco in her speech on The U. S. Economy and Monetary Policy, “I think the current stance of policy is likely to foster sustainable growth with a gradual ebbing of inflationary pressures” (2).However, Yellen further stated that "a sustained moderation in inflation pressures has yet to be convincingly demonstrated" .

Policy Actions taken by the Federal Reserve The Federal Open Market Committee in its meetings on June 27 and 28 and voted to hold the federal funds rate, the Federal Reserve’s main policy tool, unchanged at 5? percent (Monetary Policy Report 6). At the time the report was made to Congress, the funds rate has been kept at that level for the last twelve months.According to the Committee, this decision would avoid exposing the economy to the risk of a recession, while, at the same time, hoping that this policy will produce enough slack in goods and labor markets to relieve inflationary stresses. This direction will enable the Federal Reserve to achieve its dual mandate—low and stable inflation and maximum sustainable employment. The Federal Reserve System and High inflation The Federal Open Market Committee

has consistently stated that upside risks to inflation are its predominant policy concern (Bernanke). It has strong reasons behind this argument.

Monetary policies pose significant impacts on aggregate demand, real Gross Domestic Product, unemployment, foreign exchange rates, interest rates, the composition of the economy’s output, etc. However, these impacts are felt only during short periods of time. These policies, more or less, appear as stimulants to the economy rather than long-term remedies. According to John M. Roberts in Monetary Policy and Inflation Dynamics: “The notion that monetary policy should affect inflation dynamics is an old one, dating at least to Friedman’s dictum that inflation is always a monetary phenomenon (1968).

In his famous “Critique,” Lucas (1975) showed how changes in monetary policy could, in principle, affect inflation dynamics. ” In the long run, the major effect of monetary policy is on the rate of inflation. Economic conditions that are brought about by monetary policies tend to encourage increases in the general levels of prices. Take for example the lowering of interest rates – this, in general, encourages spending and investing activities which, in turn, boosts inflation rate. Low interest rates encourage people to buy cars, houses and other material goods.

Now, in the event hyperinflation takes place, the effect of monetary policies on the GDP and employment becomes non-existent. When inflation is high, firms and businesses face uncertainty about the future, and these changes the way in which they behave. Take for instance, how people may change the way in which they save. When inflation is high, there are good reasons to avoid placing deposits with financial institutions. This, in turn, affects the full utilization and maximization of

the economy’s resources and thereby affecting its growth.