Question

Should the Federal Reserve Be Independent?

While fiscal policy is voted on by Congress and can easily get caught up in partisan political infighting, monetary policy is supposed to be immune to this type of politics. In fact, it is said that the Federal Reserve is independent.

1) Is the Federal Reserve independent?

2) Can it truly be?

3) Should it be?

4) Why is important or not important for the Fed and monetary policy to be independent?

5) Do you think monetary policy or fiscal policy is more effective and why?

6) When do you think that fiscal policy should be used versus monetary policy?

Answer 1

Introduction

Market vulnerability are critical phases in an economies development and they happen at frequent intervals due to change in demand and supply dynamics in any economy. These tend to be cyclical in nature and widely affect the growth rate of an economy and other significant factors such as inflation rate, employment, prices of goods and services and the overall growth within a country.

For example:- A situation in an economy known as depression arises when the aggregate demand for goods and services reduces and has an impact that it reduces the level of production which in turn reduces unemployment and availability of capital in any economy.

To tackle such situations two main tools used across the United States and in many other countries are Fiscal Policy and Monetary Policy which are the main topics of the case study. The Monetary Policy involves making interest rate changes by the Federal Bank while, the Fiscal policy involves changing government budgets and taxation to effect the economy respectively.

In reference to the case study the answers to each of the questions are as follows:-

1. Case Specifics:-

Q1-Q4) Is the Federal Reserve independent? Can it truly be? Should it be? Why is important or not important for the Fed and monetary policy to be independent?

The Federal Reserve is indeed an autonomous body which is independent in nature and controls the economy in terms of the interest rates directly without being political in its decision making. It is truly independent in the sense that all its decision making takes place directly without the requirement for presidential approval.

Their view is in sync with the market conditions and are not hampered by political considerations. Example at times to benefit the political interests of one party, they would want the Federal Reserve to reduce the interest rates for business owners to please the same. However the Federal Bank is not supposed to take a political stand and relies only on market conditions for its decision making.

This characteristic of the Federal Bank in which they take independent decision should always remain as is. Politicians often try and create favorable scenarios for themselves while they themselves tend to have a pragmatic approach towards managing the country. This should not be allowed to hamper the economy and dynamics such as interest rates should remain stable to allow for the country to progressively grow without hurdles.

The Federal Bank makes crucial decisions from time to time which include changing the interest rates which they charge from banks or the amount of money which banks have to mandatory hold with themselves also known as Cash Reserve Ratio. If these decisions were left to the governments these could lead to serious problems in the economy and must be avoided in a capitalist based economy like the United States.

The nature of free market economies is that they should involve lesser government control on such crucial bodies.

5) Do you think monetary policy or fiscal policy is more effective and why?

While Fiscal and monetary policy both play an important role in managing the economy, the effects of monetary policy tend to be more impact making than fiscal policy which involves changes in taxation and government spending which take time to effect the economics of a country.

Further, in common opinion by economists, the role of government in making market based decisions should be restricted and they should be involved in other administrative and policy making roles for the country unless absolutely necessary.

The United States as a country has shown the world how through active monetary policy, the inflation rates can be kept stable and this has been picked across by different countries which have also achieved similar results.

Thus, due to the fact that the federal reserve is independent in nature, and the effects of Monetary Policies tend to be quicker than fiscal policy primarily because of changes in the interest rates which directly impact all sections of the society than tax changes which affect only a few and take time, monetary policies are better and allow in maintaining direct equilibrium within an economy.

Question 6) when do you think that fiscal policy should be used versus monetary policy?

While both these tools are important in impacting the economy, in my opinion fiscal policy measures such as expansion which pumps in money into the economy or contraction which increases taxes and reduces money should be restrained to extra ordinary situations which cannot be directly handled by market economics. These situations are very rate and hence fiscal policy should be used with restraint especially when you want to develop market based economies in a country.

On the other hand, monetary policy help in maintaining a general level of equilibrium and can be used regularly to alter interest rates to control the markets much before an actual market disaster takes place.

Thus the use of the federal bank should be constant so that the markets can be regulated, while fiscal policies should be used with restraint unless the market is faced with very tough situations.

While each of the policies tend to have their own cons, more and more economies are wanting restraint on direct government involvement in market based economics.

Please feel free to ask your doubts in the comments section if any.