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Economics 001A: Macroeconomics Macroeconomic Case Studies Stephen Rossi
Economics 001A: M 6:30-9:15 Slowing the US Economy The article titled 'Fed
Unlikely to Alter Course' by John M. Berry of the Washington Post takes an
interesting look at actions that Alan Greenspan his colleges of the Federal
Reserve have been taking over the last 9 months to slow the economic growth of
United States. The astonishing growth rate of 7.3% is fueled by an economy that
is in the midst of a high tech revolution. The article also explores the
contrasting view of other economists that say that the Fed has increased
interest rates too much in its attempts to slow the economy. The means by which
Alan Greenspan and the Federal Reserve have chose to slow the economy is through
a monetary policy, or more specifically, an increase in the national interest
rate.
The article states that the Fed officials have come to a broad agreement
that they will keep raising the rates until growth slows to a more sustainable
pace to make sure inflation stays under control. Because of the booming economy
and the investment in the stock market the exchange of money has increased for
goods and services, which in turn increases the price level or the quantity of
money demanded. By increasing the interest rates the Fed commits itself to
adjusting the supply of money in the United States to meet that rate at a point
of equilibrium. If the interest rate is increased, less goods and services are
demanded, and therefore will slow down the economy and reduce the rate of
inflation.
The article points out that as stock prices have risen over the last
couple of years, so have American household wealth and consumer spending. This
is precisely the cycle that Fed officials want to interrupt to slow growth
before it fuels more inflation. At the time this article was written the stock
market prices had fallen sharply especially in the technology sector. But the
Fed continued on the path to raise interest rates further noting that the index
that they closely follow and contains a broader rage of public traded US stocks,
the Wilshire 5000, is up for the year. Even though they began raising rates
gradually 9 months ago, it takes almost a year for the economy to feel the full
effects. In this case the results of the interest rates increased could be felt
as last as the second half of 2000. Yet the economy has not slowed down, and the
demand for goods and services continues to increase as wealth does.
One of the
ideas that has been presented to Greenspan by the fed officials was to take
bigger steps in raising the interest rates. They feel that this will decrease
the money demand in a quicker fashion. In turn these actions will lead to lower
consumer spending, and thus decrease the inflation rate. However, because of the
erratic patterns in today's high tech economy Greenspan is expected to stick to
his pattern of more gradual increases to the interest rate. Eventually when
monthly loan payments increase enough, consumers will back on purchases and
investments. The article points out an example where the rate for a new 30 year
fixed-rate home mortgage is up to 8.5% from 7.75% nine months ago in June. In
the situation of a $150,000 home loan, this new interest rate will add almost
$100 to each monthly payment. Over time the full effect of the interest rates
will be felt.
One economist, James Glassman of Chase Securities takes a
different look at the new interest rate. He points out that the rates that the
Fed has set are fairly high in comparison to the rate of inflation as it is
currently in the United States. The formula that Glassman follows examines the
inflation rate when food and energy items are excluded because they are so
volatile. With these items removed the rate of inflation in the US is less than
2%. As with other measurements, this rate can be subtracted from the interest
rates to find a 'real' interest rate which consumers a paying. So in terms of
30-year home mortgage rate set at 8.5%, only 6.5% of it is what the consumers
are actually paying and the rest is accounted for by inflation. Glassman goes
further to point out that with inflation so low, wages aren't going up all that
fast. To be said more specifically, the interest rates are increasing faster
than consumers' wage increases.
This will eventually be felt in the tightening
of the American economy. However with stock market fueling the incredible
momentum of the economy, the affects of the interest rate hikes have not yet
been felt, and the question has risen to whether or not the Fed's tactics are
actually going to work. However evidence is pointing back to when in 1995 the
'real' interest rate was close to 6.75% and the economy began to apply its
breaks. Between that time in now a lot of money has been placed into the
economy, and now to slow growth and inflation, the fed is using these high rates
to take some of it away. Secrets of the CPI The article Unveiling the Secrets of
the CPI by Kathleen Madicgan Focuses on exploring what exactly the Consumer
Price Index is by using some recent examples from the United States economy.
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