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Monetary Policy Essay, Research Paper

I. Introduction

In order to promote national economic goals, a central bank acts to influence the availability and cost of money and credit, this is known as monetary policy. The Fed has three main tools with which to carry out policy. These instruments of monetary policy are open market operations, discount policy and reserve requirements. Open market operations are the Fed s most important tool. It causes a change in the monetary base. When banks need to borrow money; they borrow it from the Fed. Discount policy denotes a change in the discount rate. The tool that is used the least is reserve requirement changes. It is not used often due to its power to tie up or to free resources. The Fed uses these tools to reach economic targets and to stabilize the economy. The United States economy has been growing over the past five years. The Fed has implemented policy in order to combat byproducts of this growth such as inflation and other effects. The present state of the economy has changed from the standard growth of the past and is now moving in a new direction.

II. Background Information

From 1995 until 1999 the United States economy was performing incredibly well. In 1995, real gross domestic product increased slightly less than 1+ percent over the year. A rise in aggregate output was accompanied by a steady unemployment rate of 5+ to 5+ percent. The consumer price index rose 2+ percent. 1996 saw a rise in real GDP by more than 3 percent. Employment rose substantially and was followed by a wage increase. There was a rise in prices but it was confined to the food and energy sectors. Growth was strong in 1997. More quickly than had been anticipated, the federal budget approached balance. Inflation slowed and unemployment once again dropped. In March of 1997, The FOMC raised the intended federal funds rate from 5+ to 5+ percent. Output expanded rapidly in 1998. For the third year in a row, unemployment continued to drop. Inflation remained low. The Fed has been able to keep interest rates low due to budgetary restraint at the federal level. Once again in 1999 inflation remained low. Living standards rose along with productivity growth. Over the year, the FOMC raised the intended federal funds rate by three + point increases. As output has been expanding rapidly over the past five years, falling prices for imports, especially oil, have helped the economy to perform well.

III. Current Fed Policy

July 2000 marked a slowdown in the growth of the United States economy. To contain inflation, defensive policy was used to connect aggregate demand and potential supply by raising the federal funds rate. A glimpse of growth began to appear and the Fed stopped contracting. Rather then lowering as expected, energy prices continued to rise and equity prices fell, both resulted in slowing growth even more. Appreciation in the exchange value of the U.S. dollar restrained demand for U.S. goods to foreign sectors and also slowed economic activities. The intended federal funds rate was lowered on January 3, 2001 by + percentage point. It was followed by an identical reduction at the end of the month. As energy prices rise, core inflation still remains low. The unemployment rate is at its lowest in thirty years

Growth has been falling in the first half of 2001 and the unemployment rate is expected to slowly rise to 4+ percent by the fourth quarter. There has been a large drop in mortgages since May of 2000, which will free up spending money for the private sector. Recently, investment-grade corporate bonds have fallen to their lowest levels in 1+ years.

The cost of finance and the prospective rates of return to capital will be two deciding factors on how quickly investment spending will rise in the future. An expected lowering of energy prices should keep inflation in check over the coming year. GDP is forecasted to be at 2+ percent, a growth of 2 percent.

IV. Conclusion

Through sound monetary policy, the Fed has been able to restrain unemployment and inflation rates. Most policy has been defensive and few dynamic changes have been made. History shows the U.S. economy slowing during the first two years that a republican is in office. Politics aside, do not look for substantial change to occur anytime soon. With the new tax cut, it will take time for the private sector to get that extra spending money in their pockets. When they do, look for spending to increase along with the interest rate to combat inflation. Once consumers begin to spend more, the business sector will again flourish and employment is expected to rise again. With the rise of interest rates also look for investment activity to rise. It may take a while, but the United States will again experience economic growth.


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