Justin McVay Period 4 Macroeconomics Term Paper FEDERAL RESERVE AND MONETARY
POLICY Monetary policy affects the economic and financial decisions of virtually
all of us from workers to borrowers to investors (Rukeyser 105). Louis Rukeyser
wrote, If we want monetary policy to play its proper role in a true national
economic reconstruction, the authentic task is to get the Fed to stop bouncing
like a Chinese Ping-Pong ball, switching every few months between the
inflationary effect of pumping far too much money into the economy and cramping,
recessionary effect of supplying far to little (Rukeyser 104). And, because the
US is the largest economy in the world, its monetary policy also has significant
economic and financial effects on other countries. The object of monetary policy
is to influence the performance of the economy, as reflected in such factors as
inflation, economic output, and employment. It does so by affecting demand. Most
people are familiar with the fiscal policy tools that affect demand, such as
taxes and government spending. Less familiar is monetary policy; it is conducted
by the Federal Reserve System, the nation’s central bank, and it influences
demand mainly by raising and lowering short-term interest rates. The Federal
Reserve System (the Fed) is the nation’s central bank. It was established by an
Act of Congress in 1913 and consists of the seven members of the Board of
Governors in Washington, DC and twelve Federal Reserve District Banks. Congress
structured the Fed to be independent within the government. What that means is
although the Fed I accountable to Congress, it is insulated from day-to-day
political pressures. This reflects the conviction held both the US and in many
other countries that the people who control the country’s money supply should be
independent of the people who frame the government’s spending decisions. Most
studies of central bank independence rank the Fed among the most independent in
the world (World 68). Each reserve bank President is appointed to a five-year
term by that bank’s Board of Directors, subject to final approval by the Board
of Governors.
This procedure adds to independence, because the directors of each reserve
bank, who are not political appointees, provide a regional cross-section of
interests, including depository institutions, nonfinancial businesses, labor,
and the public. The Fed is structured to be self-sufficient in the sense that it
meets its operation expenses primarily from the interest earnings on its
portfolio of securities. Therefore, it is independent of Congressional decisions
about funding. Even though the Fed is independent of Congressional funding and
administrative control, it is ultimately accountable to Congress and comes under
government audit and review. The Chairman, other governors, and Reserve Bank
Presidents report regularly to the Congress on monetary policy, and a variety of
other issues, and meet with senior Administration officials to discuss the
Federal Reserve’s and the federal government’s economic programs (World 67).
Within the Fed, the Federal Open Market Committee, or FOMC, has the primary
responsibility for conducting monetary policy. The FOMC meets in Washington
eight times a year and has twelve members: the seven members of the Board of
Governors, the President of the Federal Reserve Bank of New York, and four of
the other Reserve Bank Presidents, who serve in rotation. The remaining Reserve
Bank Presidents contribute to the committee’s discussions and deliberations. In
addition, the directors of each Reserve Bank contribute to monetary policy by
making recommendations about the appropriate discount rate, which are subject to
final approval by the Governors. The goals of US Monetary Policy according to
the Federal Reserve Act states that they are to promote maximum employment,
stable prices, and moderate long-term interest rates. The goals of monetary
policy are inconsistent. The belief that a 4% unemployment rate and stable
prices are inconsistent is shaped by the widely accepted natural rate
hypothesis. It argues that monetary policy has no effect on the economy’s
long-run equilibrium unemployment rate, which is often called the natural rate
of unemployment. The reason is that, in the long run, unemployment depends on
so-called real factors such as technology and people’s preferences for saving,
risk, and work effort; these factors are beyond the reach of monetary policy.
Most current estimates place the natural rate of unemployment in the range 5.75%
and 6.75%.
