Question

Is the current policy of the Federal Reserve “expansionary” or “contractionary”? What variables will the FOMC look at in determining the timing and size of future adjustments to monetary policy? Explain your answer

Answer 1

Current policy adopted by Federal Reserve is expansionary in nature, because Federal Reserve has kept federal fund rate to be up to 0% and it has caused other interest rates to decrease as well. As a result, cost of borrowing has decreased. So, existing policy is expansionary in nature.

FOMC will first look at the inflation rate, because it is one of the main objectives of Federal Reserve to make price stability in the economy and keep inflation rate target to be 2%. So, if inflation rate increases to be more than 2%, then FOMC takes action such as selling government securities to control the inflation. The timing should be such that economy has recovered from recession and size of change should be such that inflation comes down to 2%.

The second variable is GDP growth rate. A higher GDP growth rate, will make FOMC to move towards contractionary monetary policy and vice versa. It will be of the size that GDP growth will try to move in a direction that will help achieve potential GDP level without escalating the excess price level. The third variable is unemployment rate. A rising unemployment rate, will make FOMC to take action so that economic activities accelerates and more jobs are created. The timing should be that when there is an increase in an unemployment insurance claims and it is the buying of government securities so that money is injected. It makes firms do some investment and start production activities. It will decrease the unemployment rate.

Above are some of the variables that should be looked upon by the FOMC, to implement policies.