Monetary Economics

Monetary Economics. The committee expects that with its existing and progressive monetary policies, the labor market conditions would remain strong while the economic activity in the country would expand at a moderate pace. There would be no significant long-term risks to the economy. The committee, therefore, decided to leave the funds rate at 1.5 percent. This according to the members’ opinion, would continue rising gradually to around 2% (Federal Reserve, Npag). With regard to inflation, the committee noted that the rate was below the expected rate of 2, this would, however, move up and stabilize around the 2% target in 2018 mainly due to the strong labor market conditions in the country. The committee would also continue with its winding down of the huge amount in holdings it had acquired during the recession period of 2008. It would, therefore, allow the $12 billion of its Treasury securities to mature every month without making a replacement. This would also be the case for the mortgage-backed securities worth $8 billion.
With regard to the long-term sustainability of its monetary policies in the economy, the committee noted that it would continue assessing the expected and realized economic conditions while putting into consideration its objective of a 2% inflation and maximum employment. This would guide the size and timing of future adjustments to the fed rate. The assessments would be based on the financial and international development, inflation expectations as well as pleasure, and labor market conditions.

Though the committee expected the fed rate to continue rising, it would depend on the changing economic outlook of the nation (Federal Reserve, Npag).
What the committee did was nothing; it did not adopt any contractor nor expansionary measures but instead left the money economy to be controlled by the existing policies and the economic forces. The committee was justified to make the position taken due to a number of reasons. To start with, the rate of unemployment has been declining in recent years as seen from the Beige report and is now at a low of 4.1% which is quite amazing. The rate of GDP has also been on the increase, reflecting a 2.6% change in the current quarter from the previous. The industrial production index has also been on the increase, with the current increase reflecting a change of over 107 units showing that the real output from the various sectors in the economy has been on the increase (FRED, Npag). The country’s production capacity is therefore rising and is in a desirable state. The total non-farm payroll index has also been on the rise showing that more jobs have been added into the economy, excluding the rate of increase in the self-employed, the farm employees, unpaid employers, and private household employees. It may also suggest that the current employees have received salary increases which can only show that the businesses have experienced increases in revenue and that the economy has been performing well. It would, therefore, have been unjustified to increase the federal interest rate nor undertake other expansionary measures as the economy is doing well and there is no need for economic boosting. While the inflation rate is lower than the 2% objective, it doesn’t signify that households and business are not spending but rather that the strong dollar over the years reduced import prices that led to the low inflation rate. There is no potential danger at the moment of moving towards deflation to warrant any expansionary policies and directives. The best option would, therefore, be a long-term assessment of the inflation rate considering other economic forces as advocated by the committee. The continuous position that was undertaken towards ensuring a 2% interest level is also important as it would prevent the economy from getting into a liquidity trap where the businesses and households fail to spend but rather hold on to cash due to low-interest rates.
It is important to note that the expansionary measures adopted by the federal reserve which led to the current rates was meant to spur economic growth and increase money supply during the 2008 recession when the rate of unemployment was quite high and the GDP among other economic determinants low. Having achieved their objective as seen by the low unemployment rates, rising GDP, salaries, and output, there would be no need to continue using such measures. Maintaining a low federal rate for example when the economy was nearing full employment would only have increased the rate of inflation leading to more economic problems. The committee, therefore, started increasing the rate to prevent excess money in the economy. The current rate of 1.5 is therefore desirable as it prevents an increase in inflation while offering the environment for economic growth. The federal reserve was also left with a huge balance sheet after the economic stimulus. To normalize its policies, it has to reduce this balance sheet by getting rid of its investment in financial securities. Selling them at once may not be a good idea as it may remove huge amounts of money from the economy which may be deflationary. The best option is, therefore, to mature these securities one by one when the time comes. The maturing of the $12 billion securities during the year was a step towards this goal.
b).
The current policies have the potential to be deflationary. The committee has been increasing the interest rates by increasing the fed rate and hopes to continue doing so with time. The increased rates will mean that fewer people and business will have access to loans. There might, therefore, be reduced spending in many sectors of the economy which will lead to deflation. The committee should, therefore, continue checking on the inflation rate as it has promised to do.
c).
The dollar, which had been performing well before the beginning of last year, saw a fall in its value throughout the year. The decline in the dollar was mainly caused by the increase in the euro’s strength in 2017 when the region had one of is best financial year in a long time. The euro saw a significant rise over the dollar during the year due to political relief among other reasons. The Brexit debacle had sent chilling fears against the euro, but thanks to the decision to remain by France and Netherlands among other countries and the fact that it wouldn’t be immediate came as good news to the euro. The dollar has also performed poorly due to the political fiasco in the US. It had performed well during the first days of President Trump’s leadership due to the euphoria about his tax reforms and other economic reforms. Many had expressed high hopes in his ability to change the economy, but a series of controversies from statehouse may have seen a decrease in this hope. The US dollar has continued to decrease even after such tax cuts and the increase in interest rates. I believe that it will continue to fall relative to the euro and other strong currencies such as the Chinese Yen. China has in the recent past stocked huge amounts of the dollar to cushion its currency against the US dollar which has served to maintain its strength.
d).
I support the committee’s consensus statement as I believe it is the best way for the country to maintain economic growth. Almost all indicators show that the economy is doing well despite the decline in the dollar value relative to other currencies. Unemployment is at its lowest, and the GDP is growing. There would, therefore, be no need for a new expansionary policy but rather a policy to return the economy to long-term stability. It will be necessary to maintain the increased interest rates to prevent a situation where households and businesses hold more money without investing as the rates don’t favor investment. Prolonged low-interest rates may also increase the rate of inflation which may be more catastrophic for the economy. The committee also made a good decision by ensuring that the correctional measures are continuous as this will prevent idiosyncratic shocks in the economy. Should the federal reserve have for example sold its securities at once, there may have been the removal of huge amounts of money that may have led to temporal deflation. The decision to review the interest rate continuously will also leave it to self-adjusting forces of the economy which ensures sustainable growth.
2.
a).
The federal reserve influences money supply through two main policy categories; accommodative and restrictive. When the economy is experiencing sluggish growth, or there is reduced supply of money in the economy, the federal reserve can choose to employ expansionary monetary policies. These may include the buying of financial instruments such as Treasury bills and bonds, decreasing the federal rate, and decreasing reserve requirements. This would lead to more money in the economy and spur economic growth. When the economy is experiencing high economic growth and money supply, the inflation rate may increase substantially threatening the economy. The federal reserve, in this case, may employ contractionary policies to get the surplus money out of circulation in the economy. They can sell more financial instruments such as treasury bills and bonds, increase the reserve ratio to commercial banks, and increase the federal rate.
The economy is currently stable and with no risk of deteriorating in the coming days. The GDP is currently stable at 3.4%; the unemployment stands at 5.0% which is good, the labor participation rate is slightly on the increase and at 65% while the rate of new housing permit is on the rise. The only problem is that the current inflation rate stands at 3.1% and is slightly increasing. The committee should increase the federal funds rate by 50 basis points and lower the interest on reserve balances by 25 basis points. This will go a long way in increasing the interest rate in the economy which would discourage more borrowing by households as well as businesses. This would go a long way in reducing the available money in the economy hence controlling the rate of inflation and taking it near the acceptable 2.0%. The federal reserve should also continue allowing its long-term financial instruments that were bought during the quantitative easing period to mature as they already served their purpose. These would include the 10-year bond at 4.25% and the 20-year bond at 5.5%. The federal reserve should also consider selling its short-term financial securities such as the one year and the 3-month T-bill at 2.0% and 1.25%. By selling the financial instruments through open market operations, the federal reserve will reduce the amount of money in circulation and hold more of its reserves. This would effectively lower the rate of inflation to desired standards.
b).
Fiscal policies and monetary policies interact in very many ways leading to a sort of interdependence in the pursuit of effective economic policies. While monetary policies impact on the risk premia in long-term yields, inflation, and the short-term interest rates, fiscal policies affect aggregate demand, risk premia, real rates, and price development. Monetary policy usually affects the effects of financing decisions in the financial market and the cost of financing government debt hence affecting economic policies. Fiscal policies such as tax rates, on the other hand, affect the affect price development, reduce short-term volatility, and affect economic growth. There is a need for coordination to ensure that both policies work for the benefit of the economy as in an ideal situation, both should work to maintaining a stable economy. Fiscal policies have the capacity to improve the environment for application of monetary policies by supporting macroeconomic stability. Automatic fiscal policies are for example likely to stabilize the aggregate prices and activity level in the short term.
The major way in which fiscal policies affect monetary policies can mainly be seen through the effects of deficits and debt. Deficits are the differences between revenues and expenditures. The federal reserve would in this situation affect the servicing cost of government debt by influencing the interest rates. The monetary policy used above would, for example, have huge implications on the level of debt. The increase in interest rates as proposed would lead to a higher deficit. The government would have to reduce expenditures, raise taxes, or issue more debt to meet the deficit. High debt levels would, therefore, necessitate the adoption of other monetary policies and not the increase in interest rates. The federal reserve makes remittances to supplement the deficits, but due to the decrease in balance, the feral reserve would not be in a position to make these remittances leading to more deficits. The government can also make use of inflation to correct its debt problem. In such a scenario, the federal reserve would just sit and watch or reduce the interest rate further instead of reducing. The inflation rate has in recent times come to depend less on the various aspects of the federal reserve bank and more on the government liabilities due to an increase in the use of government debt large transactions.
c).
Two main policy categories are employed to correct economic problems; expansionary and contractionary. All the policies affect individuals and businesses in various ways whether expansionary or contractionary. When the economy is experiencing sluggish growth, or there is reduced supply of money in the economy, the federal reserve can choose to employ expansionary monetary policies. These may include the buying of financial instruments such as Treasury bills and bonds, decreasing the federal rate, and decreasing reserve requirements. This would lead to more money in the economy and spur economic growth. A lower interest rate would, for example, mean that more loans would be up for grabs by various institutions and would, therefore, encourage borrowing. The institution would have more capital at its disposal by borrowing from the willing financial institutions. More capital to the institution would enable it to expand operations to more profitable regions, produce more efficiently, diversify into other products among other activities which would lead to more profits. The institution’s investments in other organizations would also yield more during this period as equities perform well during expansionary periods when there is relatively “easy money” in the economy. As capital/money is easy to get during this period, a majority of companies or households are willing to invest in equities which leads to the rising of various companies’ stocks. If the institution has a high-risk tolerance and an aggressive investment policy, it should take the long-term approach and invest in a mix of relatively risky ventures such as real estate and stocks. A decrease in interest rates will lead to more demand for a loan as households will not have to pay much in future. The financial institution will, therefore, make more profits as more of its money will be in circulation.
When the economy is experiencing high economic growth and money supply, the inflation rate may increase substantially threatening the economy. The federal reserve, in this case, may employ contractionary policies to get the surplus money out of circulation in the economy. They can sell more financial instruments such as treasury bills and bonds, increase the reserve ratio to commercial banks, and increase the federal rate. A high federal rate will make the commercial banks to increase interest rates which will lead to reduced or no borrowings. The institution will be affected in various ways. The inability to borrow will for example make the company contend with its customer base as it may not have the capital to expand into other promising regions. The company may also e forced to produce inefficiently as there would be no means to expand its operations or benefit from economies of scale. The company may also diversify into other products leading to more profits. A restrictive economy also means that investment in equities would be unprofitable as there would be less money in circulation. Few would, therefore, choose to buy shares leading to their fall in prices. If the institution would have bought such shares, it may make some losses. Investors’ demand for higher yields in bonds during this period may also mean that bonds perform poorly during this period. If the institution had therefore invested in bonds, it would suffer some losses. The organization should consider lowering its weighting in real estate and stocks during this period to lower the probability of suffering huge losses. When the federal reserve increases the federal rate, financial institutions will have fewer customers for their bank loans as many will fear the huge amounts to be paid in future. This has an effect of decreasing the institution’s profitability. The only option is, therefore, to increase its reserves with the federal reserve to benefit from the interest on reserves.
Works Cited
Federal Reserve. “The Fed – Beige Book.” Board Of Governors Of The Federal Reserve System, 2018, https://www.federalreserve.gov/monetarypolicy/beige-book-default.htm.
FRED. “Federal Reserve Economic Data.” Fred.Stlouisfed.Org, 2018, https://fred.stlouisfed.org/.