Federal Reserve on Economic Activity and Markets

Federal Reserve’s Assessment: Current Economic Activity and Financial Markets

The Federal Open Market Committee (FOMC) has recently reported that the Consumer Price Index (CPI) for urban consumers remained the same in December 2011 as it was in earlier months. Food and energy were the only items not affected by the 0.1 percent rise in the price index in December 2011, while non-farm employment increased by more than 240,000 people in January 2012 leading to a decrease in the unemployment rate by 8.3 percent. Growth of jobs was widespread, especially in professional and business services, leisure, hospitality and manufacturing fields. In addition, it has been reported that in the last quarter of 2011, “the real gross domestic product increased at an annual rate of 2.8 percent in the last quarter of 2011, up from an increase of 1.8 percent in the third quarter of 2011” (Gagnon et al., 2011, p. 23). FOMC plans that lessening of inflation and support of an economic recovery “will maintain a highly accommodative system of the monetary policy by maintaining the target range for the federal funds rate from 0 to 0.25 percent – a rate that has been maintained since 2008” (Gagnon et al., 2011, p. 26). The Federal Funds Rate has retained its stability owing to a long period of low and negative real gross domestic product growth and high unemployment rates.

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The US economy is recovering slowly despite reports of increased employment rates and reduced inflation in 2012, which gives people a higher purchasing power compared to the period from 2008 to 2010. Investors in the home building sector are foreseeing a better market in 2012 and are, therefore, investing in more houses expecting better sales. It is also forecasted that the financial markets for the year 2012 are likely to be somewhat active, with a competitive business environment, which could lead to more revenue growth and improved financial markets, whether it is in the stocks, bonds, oil industry, factories, agriculture or any other area. However, some analysts forecast that the US Federal Reserve is likely to make more money available within the system, which will lead to scarcity of commodities and financial assets, and therefore, inflation may go up (CENGAGE Learning Asia, 2011). Asia and Europe continue to face price stability challenges, and it is, therefore, not yet clear whether the economy will be resilient enough in the prevailing financial market situation. The Federal Reserve announcement of its intention to purchase more bonds has also contributed to confidence in the gold futures. Central Banks are also increasing their gold reserves since late 2011, and it is expected that this will continue throughout 2012. The slow economic recovery has made it harder for banks to make money from loans, as the conditions are not friendly for profitable lending. It is reported that asset quality is stabilizing, and it is expected that in the long-term, bank profitability will certainly improve (Ireland, 2011).

The Federal Reserve’s Current View on Inflation

The Federal Reserve recently announced a 2 percent inflation target for the long-term. The forecast by the Federal Reserve is that even in 2014, the inflation rate is not likely to go beyond 3 percent. This is a pretty optimistic forecast and no doubt, there is a high probability that it will be realized. The main mandate of the Federal Reserve is maximum employment and price stability, which is likely to be realized soon, courtesy of the reduced inflation policy (CENGAGE Learning Asia, 2011). No doubt, the economic situation is wanting; however, there are high probability and indications of good things to come. Some Federal Reserve Economists believe that maintaining inflation to near-zero is the best monetary policy for enabling economic growth and sustainability in a nation recovering from a major recession, while others think that near-zero rate policy has its bad side.

This policy works well with the short-term business cycles dynamics of the US economy, but could also distort vital decision-making in the economy. This could lead to destructive economic growth in the long-term, especially relative to interest rates’ fluctuations. There are those analysts and economists who believe that inflation and unemployment are to be viewed at equal measure, while others are of the opinion that a temporal burst in inflation could be the remedy to unemployment. Some critics argue that (they could be right) the Federal Reserve alone is not able to fight the inflation and unemployment crises and that Congress needs to come up with fiscal policies, which will work together with the monetary policies for faster and more effective results. The Federal Reserve has always targeted low inflation rates in the long-term, and believed that core inflation measures are more realistic indicators of the economic situation, as compared to the CPI measure (Keleher, 2000).

Monetary Policy Tools used by the Federal Reserve to Stabilize the Economy and Maintain Price Stability

There are various tools and monetary policies, which are used by the Federal Reserve to achieve “maximum employment, price stability and moderate long-term interest rates” (Keleher, 2000, p56). Monetary policy is the management of money and interest rates, which uses several tools to achieve this, including; open market operations, discount loans, bank reserves, federal funds market and foreign-currency operations. Banks in the US keep a certain amount of funds in reserve with the Federal Reserve to meet unexpected outflows (Council for Economic Education, 2012). The Federal Reserve manipulates supply of reserves in the banks through open market operations, which involves selling and buying of government securities. This causes either the fall or rise of interest rates depending on the situation as determined by the Federal Reserve.

Another tool used by the Federal Reserve as a monetary policy is the federal funds market, whereby, it borrows privately from other banks to increase the reserves. The federal fund market operates in such a way that, when the supply of reserves is greater than demand, the fund rate falls and when the demand is higher than supply, the fund rate rises (CENGAGE Learning Asia, 2011). Discount rate is another monetary tool used by the Federal Reserve, where banks can borrow reserves directly at their discount windows, thereby getting a discounted rate, which is set and reviewed by the Federal Reserve Board. The discount rate is the last resort and is used when all other tools have been exhausted, as it is very expensive. Finally, foreign-currency operations are the activities in the foreign exchange markets, whereby, during some periods of disorderly declines in the dollar; the Federal Reserve purchases dollars to absorb the selling pressure (CENGAGE Learning Asia, 2011).

Opinion on Economic Outlook for the Next Twelve to Eighteen Months

I think the next 12 to 18 months look optimistic about the US economy. Based on the historic behavior of the economy which has been stable for the last few decades, I am convinced that 2012 is the year that the economy will recover to a greater extent. The forward-looking policies that have been put in place by the Federal Reserve, especially in relation to reduction of inflation are a plus (CENGAGE Learning Asia, 2011). These policies and regulations have made the recession a short-lived occurrence, and the nation can bounce back economically after a short period. Apart from monetary policies, other factors that enhance economic growth includes the growth-promoting effects of reduced government spending, positive effects of an efficiency-promoting incentive structure embedded in the tax code, increased international integration and open markets, which lead to specialization, efficiency and healthy competition. The other factor is the enhanced new technology, which has improved capacity and supply of substantial investments in valuable equipment (Saxton, 2001). I believe that economic effects can be regulated within the financial markets by putting in place tried and tested monetary policies that have worked in the past, while innovating new policies and improving the existing ones in view of the changed economic environment. Controlling the inflation rates and opening the financial markets are just examples of what could be done. This may not achieve a100 percent success, due to changes in the financial markets and environment as a whole, which really, may be uncontrollable. However, the diligence of the Federal Reserve in forecasting and planning, and putting in place monetary policies will bear positive results in the long-term (CENGAGE Learning Asia, 2011).

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CENGAGE Learning Asia (2011). Business and Economics. New York: CENGAGE Learning.

Council for Economic Education. (2012). Focus on Economic Data: The Federal Reserve and Monetary Policy. New York: SAGE.

Gagnon, J., Raskin, M., Remache, J., & Sack, B. (2011). The Financial Market Effects of the Federal Reserve’s Large-Scale Asset Purchases. New York: Peterson Institute for International Economics, Federal Reserve Bank of New York.

Ireland, P. N. (2011). Money, Banking and Financial Markets. Web.

Keleher, R. (2000). Assessing the Current Expansion. Boston: A Joint Economic Committee Study.

Saxton, J. (2001). Assessment of the Current Economic Environment. Washington, DC: Joint Economic Committee, United States Congress.

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