MONETARY POLICY

Monetary Policy and Inflation

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http://www.federalreserve.gov/newsevents/press/monetary/20111213a.htm

1. Monetary Policy and Inflation" Please respond to the following:

From this week’s e-Activity, examine two methods that the Federal Reserve can implement to support a stronger economic recovery. Provide support for each method in your response.

The methods which the Federal Reserve implements in order to support stronger economic recovery is to find a way so as foster maximum employment and also the price stability. This is because, there have been a moderate pace of employment growth over coming quarters and it soon anticipates that unemployment rate would have declined only towards levels which are put forwards. The implementation of maximum employment would certainly attribute to a settling down the inflation and overcome the coming quarters (Friedman, 2001). The price stability would certainly attribute to a stronger economic recovery because it would attain the same degree to which prolonged inflation and deflation emerges. This is because the price stability tends to avoid both the prolonged inflation and deflation. Certainly, the price stability establishes a high achievement of economic activity levels together with employment through improving price mechanism transparency, reducing inflation risk preferably in interest rates. Therefore the recovery of the stronger economic is absolutely in accordance to implementation of maximum employment and price stability.

Identify one way that the Federal Reserve’s actions have influenced a recent decision that you have had to make. Explain the basis for your decision.

The Federal Reserve possesses the nontraditional monetary policy measures in order to provide the additional support to economy. The main role of the purchases is to diminish the level of the longer term interstates hence improving the financial conditions (Bean, 2003). The nontraditional monetary policy works through broad channels significantly to traditional policy.

2."Money" Please respond to the following:

Given our current economic situation, determine the steps that the Federal Reserve should take to help stabilize our economy.

The first step which the Federal has to consider in order stabilizing economy is to control the money supply. This step would help in stabilizing economy because the amounts of money which are to be controlled include the highly liquid assets like currency and checking deposits. If the Federal Reserve controls the supply of money it would be possible to control open market operations (Friedman, 2001). The second step is to raise the interest rates and stop buying Government bonds as well as mortgage backed securities. Thirdly, the Federal Reserve has to make consumer goods and export them to other countries which can manage those markets hence stabilizing the economy. This means that if the Government is forced to cut the spending then it would certainly stabilize the economy as a result of debt restructure.

Explain how each of the following variables will be affected by proposed steps that you have identified in the first part of the discussion: money supply, interest rates, inflation rate, aggregate demand, and output. Provide support for your response.

Money supply would be affected by the proposed steps through a change in reserve requirements, a change in discount rate together with open market operations. Certainly, the Federal Reserve uses tools in order to control money thus stabilizing economy. Once the economy is slumping, Fed tend to increase supply of money so as to spur the growth and when inflation is quite threatening the Fed tend to reduce risk by shrinking supply. The inflation rate is affected in a way that, there would be no sustain increase in price over a period of time (Bean, 2003). In a clear concise, the short term real rates low results to higher inflation and also higher nominal interest rates without permanent growth of the output or a decrease in unemployment. It aims on managing the unit of currency in order to avoid buying of fewer goods and services.

The proposed steps would affect the interest rates through activity stimulation. Once the economy is overheating, there is a raise in interest rate to which it dampens the economy activity. Also when economy is not performing well, there is a suggestion to cut interest rates (Debelle, 1989). The Federal Reserve has ability to affect the level of interest rates consistently in economy matters.

The aggregate demand would be affected by the proposed steps through preferring lower price level of demand goods and services. This is because the price level and quantity of the output are negatively related to the total spending. The Federal Reserve tends to explore the scenario which occurs if a price level rises as a result of imbalance preferably in aggregate supply and demand (Debelle, 1989). The Output would be affected by the proposed step in a way that the long run output which is measured by GDP is quite fixed and the changes in money supply is valuable only to cause the price change. However, considering the short run the effect which has to be identified is that because the prices and wages usually do not adjust suddenly the changes within money supply have to affect the actual production of the goods and services. The increase in demand would actually put pressure on the input costs like wages.

References

Friedman, B. M., Solow, R. M., & Taylor, J. B. (2001). Inflation, unemployment, and monetary policy: The Alvin Hansen Symposium on Public Policy, Harvard University. Cambridge, Mass. [u.a.: MIT Press.

Bean, C. R., & Bank for International Settlements. (2003). Asset prices, financial imbalances and monetary policy: Are inflation targets enough?. Basel, Switzerland: Bank for International Settlements, Monetary and Economic Dept.

Debelle, G., & International Monetary Fund. (1998). Inflation targeting as a framework for monetary policy. Washington, D. C: International Monetary Fund.