Analyzing Fed Policymaking 1996-1998 - Term Paper Example

With upward rising of the aggregate, there are favorable conditions to drive economic growth such as high job creation, high production, and business expansion. The Federal Reserve policies between 1996 and 1998 were aimed at stimulating growth in ensuring increased productivity, which resulted in increased employment and reduced inflationary rates through control of interest rates. A report by Federal Reserve Board (1999) showed that, economic growth between 1996 and 1998 was remarkable and stronger than many had expected.

The economy growth was more than 3.5% in 1997 and between 2.5 and 3.0 % in 1998. By 1998 the real GDP growth was at 3.5%, and was expected to rise further in the following years (Lewis, 1998). According to Lewis, at the start of October 1998, the S& P was abnormally high having risen from about 1000 in earlier years to about 1400 by July 1999. The Fed had to impose a 40% increase in the S &P by hiking interest rates from 4.75 to about 6.5 in the following years. This rise resulted from an “irrational exuberance’ where too much money was being injected into the booming internet and technology industries (Lewis, 1998).

Figure 1 portrays the general trend of interest rates during this period, Figure 2 portrays the relations between money supply and price levels between 1950 and 2008, while figure 3 shows the dollar performance compared to German’s in 1998. The major driver of the U.S economy that resulted in a high economic growth between 1996 and 1998 was capital spending. Many organizations continued to invest heavily in information technology and modernizing communication equipment to improve their productivity (Lewis, 1998).

The market interest rates affect borrowing and lending policies, which affect the production and consumption of goods, products and services. The Federal Reserve Board (1999) explains that, these factors largely influence employment and job creation; high interest rates will discourage investors hence low job creation opportunities. For example, during this period, Fed decided not to hike the interest rates to control the exponential market growth in preventing the economy from tending to inflation.

This is observed in graph 1. In the year 1996, it was expected that inflation and interest rates would be on the rise towards the end of that year, but it turned otherwise (Federal Reserve Board, 1999). As Mishkin (115) explains, the demand for money and interest rates are inversely related using the opportunity cost aspect. This is the expected return sacrificed by an investor by not holding the alternative asset, which refers to a bond in this case. Moreover, demand for money is determined by the wealth or income and the price levels in the market (Mishkin, 116).

The federal authority polices during this period were aimed at robust growth in employment, recovery and strengthening of the dollar, and regulated interest rates, which increased wealth and lowered the interest rates making the demand of money to increase. There was a general fall of the domestic interest rates and national debts over this period (Mishkin, 11). In the third quarter of 1998, uproar in financial market globally resulted in a sharp drop in value of the dollar, having dropped from DM 1.

7993 to DM 1.6718, which could have shifted the economic growth as well as interest rate policies towards encouraging more borrowing. Low interest rates contributed