Question

Considering the Federal Reserve's aggressive expansionary monetary policy since the beginning of the Great Recession in 2007, and the latest stance on Monetary Policy to maintain the accommodative policy of a target Federal Funds Rate (FFR) at 1-1.25% interest rates while beginning the balance sheet normalization program...

A) What are the predicted effects on GDP and on inflation?

B) How is the stock market reacting?

C) What are the "labor market supports" anticipated?

D) How much upward pressure on prices may result? Hint: Think about: How is the federal funds rate determined?

E) What is central to the Fed's internal debate?

F) What is the Federal Reserves "dual mandate?"

Answer 1

(a) Expansionary Monetary Policy:

Expansionary monetary policy increases the money supply in an economy. The increase in the money supply is mirrored by an equal increase in nominal output, or Gross Domestic Product (GDP). In addition, the increase in the money supply will lead to an increase in consumer spending. This increase will shift the aggregate demand curve to the right.

In addition, the increase in money supply would lead to movement up along the aggregate supply curve. This would lead to a higher prices and more potential real output.

The Effect of Expansionary Monetary Policy

An expansionary monetary policy is used to increase economic growth, and generally decreases unemployment and increases inflation.

(b) Impact on stock market :
Monetary policy can be restrictive (tight), accommodative (loose) or neutral (somewhere in between). When the economy is growing too fast and inflation is moving significantly higher, the central bank may take steps to cool the economy by raising short-term interest rates, which constitutes restrictive or tight monetary policy. Conversely, when the economy is sluggish, the central bank will adopt an accommodative policy by lowering short-term interest rates to stimulate growth and get the economy back on track.

The impact of monetary policy on stock market is thus direct as well as indirect. The direct impact is through the level and direction of interest rates, while the indirect effect is through expectations about where inflation is headed.

(c) Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined.

(d) The rate is primarily determined by the balance of supply and demand for the funds. But it fluctuates. A target rate is set by the Federal Open Market Committee (FOMC) but the actual rate that's used overnight can be higher or lower, depending on supply of funds and the demand by banks for loans.

The US Fed on Wednesday raised bank rates by 25 basis points on expected lines. It also announced plans for unwinding by initially trimming reinvestment in treasury securities by $6 billion per month.