Question

1. Explain about the main goals of the Fed's monetary policy in terms of three primary macroeconomic indicators.

2. Explain about the tradeoff between the Fed's short-run and long-run goals, i) when it implements an expansionary monetary policy and ii) when it implements a contractionary monetary policy.

Essay Format at most 500 words

Answer 1

1. The Federal Reserve works to promote a strong U.S. economy. The Congress has directed the Fed to conduct the nation's monetary policy to support three specific goals:

i) Maximum sustainable employment: It is the highest level of employment that the economy can sustain while maintaining a stable inflation rate.

ii) Stable prices: Prices are considered stable when consumers and businesses don't have to worry about rising or falling prices when making plans, or when borrowing or lending for long periods. When prices are stable, long-term interest rates remain at moderate levels, so the goals of price stability and moderate long-term interest rates go together.

iii) Moderate long-term interest rates: The Fed seeks to achieve its monetary policy mandate by influencing interest rates and general financial conditions.

For example, by keeping policy interest rates low, the Fed makes homes more affordable for consumers and makes it cheaper for businesses to invest, expand, and hire. And by raising policy interest rates when inflation pressures are building, the Fed helps to cool the economy and preserve price stability.

2. (i) Expansionary monetary policy: It is when Fed uses its tools to stimulate the economy. It increases the money supply, lowers interest rates, and increases aggregate demand. It boosts growth as measured by GDP. It usually lowers the value of the currency, thereby decreasing the exchange rate.

(ii) Contractionary fiscal policy: It is when the government either cuts spending or raises taxes. It gets its name from the way it contracts the economy. It reduces the amount of money available for businesses and consumers to spend. Its main purpose is to slow growth to a healthy economic level.

When governments cut spending or increase taxes, it takes money out of consumers' hands. That also happens when the government cuts subsidies, transfer payments including welfare programs, contracts for public works, or the number of government employees.

Shrinking the money supply decreases demand. It gives consumers less purchasing power. That reduces business profit, forcing companies to cut employment.