Question

The Federal Reserve and Monetary Policy" Visit the Federal Reserve website and answer the following questions in your own words. Part 1: What is the mission and legal mandate of the Federal Reserve System? What policy tools are available to the Fed to achieve its mission? What is the difference between an insolvent bank and an illiquid bank? Why/how does the Fed treat banks that are insolvent differently from illiquid banks? Part 2: The Fed has only increased the interest or discount rate twice since the 2007/08 recession. Will it push the rates up a bit more? We don't know! We can find out what those at the Fed are thinking by checking out posted information each month by the FOMC (Federal Open Market Committee). According to the Fed, what are its inflation and full-employment targets? Explain how changes in the money supply will raise interest rates and how the anticipated increase in interest rates will likely affect GDP and employment.

Answer 1

Federal Reserve policymakers have abandoned the notion that they can bring the U.S. economy in for the perfect soft landing — when inflation settles at its target, growth throttles back smoothly to trend and monetary policy shifts to neutral.

Instead, they’re prepared to step on the brakes.

“Nearly all” Fed officials believe that the central bank will have to restrict the economy by pushing interest rates above their long-run equilibrium level to achieve their aims, according to the minutes of their Dec. 12-13 meeting released this week.

The central bank is more likely to make a policy mistake and inadvertently push the economy into a recession if it is actively seeking to curb credit and increase unemployment, rather than just removing monetary accommodation from the financial system, as it is now.

Striking the right balance may present political risks, too. That challenge will fall to Fed Governor Jerome Powell, whom President Donald Trump chose to replace Chair Janet Yellen when her term ends Feb. 3. Efforts to slow the economy — to effectively put people out of work so inflation doesn’t run out of control — could run counter to the employment and economic growth goals of the administration.

In a speech in January 2016, New York Fed President William Dudley noted that the economy historically “has always ended up in a full-blown recession” whenever unemployment has risen by more than 0.3 to 0.4 percentage points.

Fed officials forecast that the unemployment rate will fall to 3.9 percent at the end of this year, and then stay there, before inching up to 4 percent at the close of 2020. That would still be below November’s 4.1 percent rate and would be under the 4.6 percent level they reckon is equivalent to full employment.

The central bank has pushed unemployment so far below the setting it considers sustainable in the long term because of the difficulty it’s had lifting inflation to its 2 percent goal.

Since the target was adopted in January 2012, inflation has been below the central bank’s objective more than 90 percent of the time. In November, the personal consumption expenditures price index was 1.8 percent higher than a year earlier.

So far, the amount of tightening envisaged by U.S. central bankers is not that big. Policymakers expect the federal funds rate to rise to 3.1 percent at the end of 2020, a bit above their longer-run neutral rate of 2.8 percent, according to their median forecasts.

The “nearly all” formulation in the minutes, though, does suggest that even some of the more dovish members of the Federal Open Market Committee think they eventually will have to raise rates into restrictive territory.

Fed officials raised their target range for the funds rate to 1.25 percent to 1.5 percent at the December meeting and penciled in three more quarter percentage-point increases for this year.

The U.S. labor market ended a year of solid growth on a disappointing note in December, but economists said tax cuts are set to breathe some new life into the gradually decelerating employment recovery.

December’s gain of 148,000 net new jobs, reported Friday by the Labor Department, was down sharply from an upwardly revised 252,000 net new jobs added in November.

December’s job creation was enough to push 2017’s total over 2 million for the seventh straight year, although the figure was down slightly from 2016. The only other time the U.S. added more than 2 million jobs annually for such a long stretch was during the internet-fueled boom of the 1990s. Despite the December slowdown, job creation averaged 204,000 over the final three months of 2017. That was the best quarterly pace since mid-2016.

The unemployment rate remained at 4.1 percent for the third straight month. That is the lowest since the end of 2000.

The unemployment rate for blacks, at 6.8 percent, was higher than for the overall population but down more than a percentage point over the year to the lowest level since the Labor Department began tracking it in 1972.

The rate for blacks dropped from a high of 16.8 percent in early 2010. The unemployment rate for Latinos matched a post-1972 low of 4.8 percent in November, but rose to 4.9 percent last month. It had been 13 percent in 2009.

The relative decrease in the rates for blacks and Latinos matches that of the overall unemployment rate, which fell from a recent high of 10 percent in late 2009.

The overall unemployment rate held steady in December because the workforce grew only modestly, by 64,000. The percentage of working-age people in the labor force remained at 62.7 percent last month, near a four-decade low.

Average hourly earnings rose 9 cents to $26.63 in December after just a three-cent rise in November. Wages were up 2.5 percent in 2017, about the same annual gain as the previous two years.

Gary Cohn, the top economic adviser to President Donald Trump, said Friday that he wanted monthly job growth of more than 200,000. The corporate and individual tax cuts that took effect Monday will help push hiring back up to that level this year and spur higher worker pay, he said on Bloomberg TV.

“We see the economy continuously growing and continuously adding jobs, and remember tax reform is now five days old and the input that that’s going to have into the economy is … just barely starting to have an effect,” Cohn said. “We are committed to real wage growth and we do believe you’ll see it over the course of the next year or two.”

Job growth has been trending down since 2014, indicating the nation is nearing full employment as the recovery from the 2007-09 recession is more than eight years old.

Overall in 2017, the economy added 2.06 net new jobs. That was down from 2.24 million in 2016 and well off the nearly 3 million jobs added in 2014.

A continued decline in the retail sector, which eliminated 20,000 jobs in December and 67,000 for the year, was a key factor in the slowing growth last month. Brick-and-mortar retailers are struggling in the face of increased online shopping, economists said.

Retail losses were offset by solid gains in health care, construction and manufacturing last month, the Labour Department said.

Still, the labor market right now is “about as good as it gets,” said Mark Zandi, chief economist at Moody’s Analytics.

“It’s not picture perfect, but it’s a pretty picture,” he said. “I think that business’ No. 1 problem is already finding qualified workers and that problem is already finding qualified workers and that problem is going to intensify as the year progresses.”