U.S. Monetary Policy and International Implications - Essay Example

of the of the Number U.S. Monetary Policy and International Implications Introduction The economy of the United States has been passing through rough winds since 2007. However, since the middle of 2009 the economy is showing weak signs of growth. While economic activities are expanding at a modest pace, rate of unemployment remains stuck at a high level (Press Release). The pace at which the economy is recovering is too slow and experts consider this rate of economic growth as frustratingly insufficient for taking the economy of the U. S. back to higher standards of economic performance. The effects of the headwinds experienced by the U.S. economy include different aspects of the country’s economy as well as the economy of other countries in the European continent. The effects include deleveraging by the U.S. households, persistent weakness in the U.S. housing market, tightening of conditions and availability of credit in certain sectors, spillover effect of the crisis situation in U.S. to Europe and contraction of fiscal policies by the Federal government at all levels of the economy. This has created concerns regarding the outlook of the Federal government about its fiscal policies in the short and medium-term. This paper looks in to the policy prescriptions of the monetary policy making group of the Federal Reserve System and investigates the issues arising from these policies. Alternative policy solutions are thereafter discussed in this paper. U.S. and Global Outlook The effects of crisis have been intensified by the activities of the households and business groups. Both these sections of the economy have made spending and investments cautiously. The members of The Federal Open Market Committee (FOMC) meet eight times every year in Washington, D.C. and devise all monetary policies for the Federal Reserve System (Federal Open Market Committee). This Committee has several other responsibilities besides formulation of monetary policies. In these years of unstable economic situation of the U.S. economy, the FOMC is trusted with the liability of setting the target rate for federal funds, the rate of interest charged by banks from each other on account of short-term loans. Since the pace at which the economy is growing seems insufficient to initiate and sustain considerably large up-gradation in the current job market, the FOMC has decided to take measures and modify its financial policies to bring significant changes in the employment levels. The rate of unemployment has been recorded at a high 7.8 percent in 2012, which is much higher than the projections made by analysts as the normal level of unemployment in the long run (Bernanke). There is a large level of slack in resources in the U.S. and it is being persistently maintained with high margins. This supports the restrained rates of inflation in the U.S. although there are short term fluctuations in prices of goods and services in the economy. Consumer price inflation at present shows lower than the expected level that is required to achieve the long run objective of 2 percent as set by the Federal Reserve (Press Release). Federal Reserve's Recent Policy Actions The monetary policy strategies of the Federal Reserve are steered by the dual mandate of promoting maximum level of employment and achieving stability in prices (Mayer 184). With the inadequate progress found in the US job markets coupled with subdued inflationary pressures, the Federal Open Market Committee (FOMC) has taken certain important actions in 2012 with the aim of providing “additional policy accommodation” (Bernanke). In September of 2012 information collected from reliable sources continued to let out weak signals regarding labor markets. There were also no sign of noteworthy inflation pressures. This induced the FOMC to take additional steps for making provisions of policy accommodation. The span of time over which the FOMC has kept its expectations “to maintain exceptionally low levels of the federal funds rate” (Bernanke) has been extended from the later months of 2014 to the middle of 2015. As the economic recovery would start showing signs of strengthening, the FOMC would expectedly maintain an accommodative attitude towards the monetary policy formulated by the Committee for a considerable long period of time. The FOMC would also make additional purchases of asset and has announced that it would procure agency mortgage-backed securities (MBS) at a rate of 40 billion US dollars per month. This purchase would be made beyond the stipulated 45 billion US dollar of monthly purchase of the long-term Treasury securities under the maturity extension program (MEP) (Potter). The FOMC has indicated that it would continue to employ these tools and embark upon similar other tools, for the period of time that would be deemed necessary to improve the conditions of labor market substantially and move towards price stability. These asset purchases display an open-ended nature and sets explicit condition on making improvements in the state of affairs of the labor market. It provides the FOMC with the desired level of flexibility helping it to respond to economic necessities thereby installing greater confidence in the minds of the public; on this line- the Federal Reserve is empowered to take necessary actions to further promote strong economic recovery while ensuring price stability. In this context, a transparent financial framework followed by the Committee would be able to evoke better public confidence and consequently promote job creation in the coming quarters thereby augmenting the process of economic growth of the economy. Strengths of the accommodative monetary policy of FOMC The FOMC has decided to maintain its purchases of mortgage-backed securities and long-term treasury securities at the rate of $40 billion per month and $45 billion per month respectively. The committee has plans to maintain the policy of dual reinvestment. It would reinvest the “principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities” (Press Release) and roll over the maturing treasury securities at auction. The asset purchases made by The Federal Reserve are designed in such a manner that they are capable of reducing risks from the private investor’s portfolios (Potter). The combined effect of these two actions would create a downward thrust on the interest rates in the long term and support the mortgage markets, thereby allowing the decision making body to make more accommodative financial conditions. Reduced rates of interest would lead to lower prime rates and increase consumer spending (Pope). It would increase competitiveness of the U.S. enterprises (Hilsenrath). In its endeavor to determine the composition, size and pace of the asset purchases made by the Committee, it would also take account of the costs of these purchases and compare them with the efficiency of the assets. These evaluations would further push the Committee to modify its objectives and activities in accordance with the immediate needs of the economy and to maintain the level of economic progress (Press Release). Weaknesses of Federal Reserve Asset Purchases The above mentioned activities of the Federal Reserve have significant effects on the world economy besides influencing the labor market of the United States. On one hand the monetary accommodations made by the FOMC is critically supporting the economy of the United States, many scholars and experts have raised concerns that these policies are going to have spillover effects on the trading partners of the country. Some critics of this policy prescription have particularly argued that the action of asset purchasing under the accommodative monetary policy leads to high amounts of capital outflow from the US to the emerging economies of the world. Such capital flows would potentially cause unwanted currency appreciation due to excessive liquidity. High levels of liquidity in these market economies might pose the threat of inflation or create asset bubbles in these economies. Asset bubbles might burst in the long term creating economic disruptions since, in such cases, the reverse capital outflow might happen as quickly as capital inflows had taken place in these economies. Economic disruptions in the emerging market economies would also affect the operations of the developed economies since they are part of the global market. Alternative policy choice and justification While the asset purchase program of the FOMC is aimed at increasing employment levels and improve job market conditions along with stabilizing the price of commodities in the U.S. economy, this policy action also has certain significant negative impacts. In my opinion, although the quantitative easing puts a positive influence on the economic performance of the country, the government has to increase subsidy on labor wages and increase demand for labor by the producers. An increase in wages would improve demand conditions in the economy which would increase productivity levels (Neumark 2). While improving demand conditions in the economy, this process would take care of the problem of excess liquidity in the economy. There has been a lot of discussion about the activities of the FOMC. Rampant speculation has been centered on the Federal Reserve’s action (Eisenbeis). It is clear that the asset purchasing policy has a two way impact on the economy and it would not be justifiable to deal with it in one-sided manner and propose an alternative policy by rejecting this policy altogether. Conclusion Mixed views have been provided in the debate revolving around the asset purchasing by the FOMC. In terms of efficiency of the quantitative easing program, most of the members of the Committee have agreed that this policy creates a meaningful result by easing financial circumstances thereby accelerating the process of economic growth. According to these observers, less credit constraints and lower rates of interest would increase investment by investors. On the other hand, some members of the Committee consider this policy as having a diminishing impact on the economic condition of the country (Baumol and Blinder 302). This is because quantitative easing lessens the financial stress in the short term, but, no consensus has yet been reached with regard to the long term effects of the assets purchasing policy. Works Cited Baumol, William Jack and Alan Stuart Blinder. Macroeconomics: Principles and Policy. Connecticut: Cengage Learning, 2011. Print. Bernanke, Ben. “Speech”. Federal Reserve. Board of Governors of the Federal Reserve System, 2012. Web. 16 May 2013. Eisenbeis, Bob. “When Will the Fed Act and What Will It Do?” Cumber. Cumberland Advisors, 2013. Web. 16 May 2013. “Federal Open Market Committee”. New York Fed. Federal Reserve Bank of New York, 2012. Web. 16 May 2013. Hilsenrath, Jon. “Will Fed Act Again? Sizing Up Potential Costs. ” The Wall Street Journal. The Wall Street Journal. 2013. Web. 16 May 2013. Mayer, Thomas. The Political Economy of American Monetary Policy. Ed. Cambridge: Cambridge University Press, 1993. Print. Neumark, David. “Alternative labor market policies to increase economic self-sufficiency: Mandating higher wages, subsidizing employment, and increasing productivity”. Working Paper, 2009. Massachusetts: National Bureau of Economic Research. Pope, Ethan. “When the Fed raises or lowers interest rates”. Foundations for living. Foundations for living, 2007. Web. 16 May 2013. Potter, Simon. “The Implementation of Current Asset Purchases.” New York Fed. Federal Reserve Bank of New York, 2008. Web. 16 May 2013. “Press Release”. Federal Reserve. Board of Governors of the Federal Reserve System, 2012. Web. 16 May 2013. Read More