Discussion Forum (ECONOMIC)

it is no surprise the overwhelming class consensus is the US economy is still producing below the full employment level of labor and capital, or "potential output," causing a "recessionary gap" in income and output, but that recessionary gap is slowly closing. Many of you referred to the BLS' labor statistics, US GDP and small growth in wages. With this in mind, this week’s focus is Monetary Policy. The central bank of the US oversees the monetary system of all 50 states, and faces a dual mandate of maximum employment and price stability.

Please review the sources (below) and review other recent sources on monetary policy and think about how money is created. (See Forbes, Wall Street Journal, and New York Times)

Consider the following:

After the Federal Reserve's aggressive expansionary monetary policy since the beginning of the Great Recession in 2007, do you agree with the Fed's latest stance on Monetary policy, waiting to increase interest rates? Will there be any effect on GDP? on Inflation? on the stock market? Further declines in the unemployment rate? How much upward pressure on prices may result? Hint: Think about: How is the federal funds rate set? What is central to the Fed's internal debate? 

Are you in favor of, or opposed to "slowly beginning contractionary monetary policy,(raising interest rates soon)" and why/why not (support your argument with data and theory)? Remember, the Fed oversees the entire monetary system of the US, and faces a dual mandate of "maximum employment and price stability." Take into consideration what is happening in Texas, North Dakota, West Virginia, Wyoming, as well as Oregon as you frame your response.

Developments in the Greek crisis justifiably diverted attention from Federal Reserve Chair Janet Yellen's semi-annual testimony to Congress last week.

The Fed's Countdown

Most of the coverage tended to focus on Yellen's valiant efforts to parry attacks on the autonomy and accountability of the central bank (past, present and future). Yet the Fed chief also provided important insights about the future of interest rate policy:

1. Timing: Based on what she knows today, Yellen is inclined to initiate the Fed's hiking cyclethis year, and perhaps as early as September. Instead of waiting until 2016, when she might have to raise interest rates more aggressively, she would rather lead a gentle campaign of increases that starts this year and proceeds gradually, as new economic data warrants.
2. Rationale: Although wage growth remains too muted, Yellen anticipates the labor market will strengthen further, carried by robust job creation. Combined with moderate growth in domestic demand, the brighter employment picture is expected to underpin the continued rebound from disappointing first-quarter growth.
3. Not just cyclical: Yellen seems to be warming to the notion that the U.S. economy faces more than cyclical headwinds. By taking into account the role of structural issues, including moderate productivity growth and sluggish supply responsiveness, she can be less worried about inflation persistently undershooting the Fed's objective. 
4. International context: Although the Greek crisis is of concern, Yellen doesn't believe that its effects are limited to the downside. She also sees upside risk for Europe.
5. Format: The Fed chief provided further indications that this would not be a traditional cycle. Instead, it is likely to involve a new kind of stop-go pattern. Previous Fed chairs have preferred to set hikes at each meeting until their desired rate destination is reached. Yellen will adopt a more conditional approach.
6. Terminal point: Yellen also is warming to the idea that the increases could end with a policy interest rate that is well below historical averages, but she has offered no further details.
7. Global divergence: While concerns about the strength of the dollar could re-emerge, they weren't described as an impediment to initiating the interest rate hiking cycle this year. At this stage, Yellen isn't overly worried that the Fed, with a policy of reduced monetary accommodation, will diverge even further from other central banks (particularly the European Central Bank). 

Even though she provided these guideposts on her thinking, it also was obvious that Yellen wishes to retain significant policy flexibility. This was clear in her reluctance to attempt to manage market expectations more aggressively. Over the last few months, some investors have erred in anticipating that the rate hikes would begin in 2016. They would pay more attention to Yellen's seven points and change their expectations if, as is likely, the U.S. economy continues to heal, and if the latest Eurogroup deal rapidly restores some sense of normality to the imploding Greek economy (which is possible, but much less likely).

Source: http://www.bloombergview.com/articles/2015-07-20/yellen-s-7-reasons-to-expect-a-2015-rate-increase

Chair Janet L. Yellen

At the "The New Normal Monetary Policy," a research conference sponsored by the Federal Reserve Bank of San Francisco, San Francisco, California

March 27, 2015

Normalizing Monetary Policy: Prospects and Perspectives

(Excerpts provided): I would first note that the current stance of monetary policy is clearly providing considerable economic stimulus...Second, we need to keep in mind the well-established fact that the full effects of monetary policy are felt only after long lags...An important factor working to increase my confidence in the inflation outlook will be continued improvement in the labor market...The spending and investment decisions the FOMC seeks to influence depend primarily on expectations of policy well into the future, as embedded in longer-term interest rates and other asset prices...my FOMC colleagues and I generally anticipate that a rather gradual rise in the federal funds rate will be appropriate over the next few years. (full speech Copy this link, and paste it into your web browser: http://www.federalreserve.gov/newsevents/speech/yellen20150327a.htm)