Economics Term Paper on the Federal Reserve and inflation in the US in the past few years

The Federal Reserve and inflation in the US in the past few years

The Federal Reserve System was adopted in the US when some of the state banks that held federal government deposits failed. The failure of the banks led to the establishment of an Independent Treasury system, which kept its funds in its own vaults and in various sub-treasuries around the country. When the government did not have high expenditures or receipts this system was adequate, but during the Civil War this system had to be changed (The Economist 6).

Inflation is the rise in prices of goods and services, which is accompanied by the rise in living standards. Though inflation often occurs, there is no provision or increase in salaries to counter the increase or rather rise in prices of goods and services. The increase in inflation is one of the major goals of the Federal Reserve. This is because inflation is often believed to strengthen the economy of any particular country. For instance, the Federal Reserve’s aim was to achieve an inflation of 2% in the US. Though this was to be accompanied by increased employment opportunities and rise in discount rates hence consumers would not suffer. The inflation was pushed when the Central Bank in the US decided to increase its interest rates on the domestic banks and other consumers. This was a major setback to the entrepreneurs who had to increase the prices of their goods and services (The Economist 6).

According to “The Economist,” low inflation is always a choice. Besides, in the US, the Federal Reserve has total control over the short-term interest rates that are given to customers by various financial institutions with target of fighting inflation and its expectations. In fact, the Fed has come with a goal of achieving its target of 2% in the long-term. It would be worth noting that in achieving this, the Fed has excluded other sectors such as volatile food and energy. Volatile food and energy are some of the critical sectors that determines the survival and existence of common person. Any slight increase of goods and services from these sectors would mean that there would be suffering of humankind. Since the inception of the Federal Reserve in the US, core inflation has never been one of its targets. Instead, the Fed has used core as a major indicator since past core inflation can act as a better indicator or rather predictor of future headline inflation than past headline inflation. During situations when there are shortfalls with inflation, monetary policy does not have the capability of reaching or rather hitting a particular price level or rate of inflation. That is to say, the origin of monetary impotency is when there is existence of monetary shortfall and employment shortfall. This is the point when a number of financial institutions often allow very little inflation since they have the belief that hiring or employing people is more expensive. This is in contrast to the stand of the Federal Reserve that believes in more inflation and more growth of employment at the same time. The bigger worry is that the Fed has been missing out on inflation and employment issues on purpose. Several people have not understood the reason behind this, but it is believed that the Fed has had negative thoughts and conclusions that the monetary policy that is accommodative would result to high risks of financial stability. The Fed rolled out a new program of open-ended quantitative easing in 2012, which led to a reduction in inflation expectations. The market at that time was behaving as though the Fed had total control over inflation. Inflation should thus be encouraged as long as there is more creation of employment opportunities. This is because low inflation contributes to financial instability. However, it would be funny to come to terms with the Fed’s reasons for supporting low inflation. Maybe the Fed has the belief that when the inflation is too high, then there would be high possibility of financial risks.

Additionally, according to an article in “The Wall Street Journal”, the Federal Reserve, in January 2012, made an announcement that it had a goal of achieving 2% inflation. The Fed also had the aim of making the prices of consumer goods in the US advance at a rate of 1.3 % annually. The Fed’s target was achieved because prices of consumer goods and services have slightly increased in the past two years. However, despite the struggles, the leadership of the Federal Reserve Bank of Minneapolis has been involved in a number of debates. The debates are about whether the Fed should be committed to coming up with a policy that would ensure return prices or promote the increase in inflation rates of consumer goods and services. The major opinion that the leadership of the Fed has come up with in the past few years with the consumers in mind, is price-level targeting. That is to say, instead of targeting a continuous rate of inflation, the Fed together with the central bank of the US, will keep an eye on the steady rise of the price level of various consumer goods and services. The steady rise in the price of consumer goods and services is to some extent better than inflation as the consumers’ employment pay rise is a gradual process and it would go hand in hand with a gradual but steady rise in the prices of goods and services thus not becoming kind of hectic to the consumers (The Wall Street Journal 3).

Furthermore, the Federal Reserve has leaders that mind about the consumers, who are among subjects that make the Fed so relevant. For example, Mr. Kocherlakota is one of the leaders of the Fed and he is majorly in support of low interest rates and easy-money policies. Mr. Kocherlakota is one of the several leaders of the Fed who have been supporting an increase in the employment rates in the US. Their major reason for pushing for employment is that a higher rate of unemployment would lead to a significant drop in the economy of the US. The fall in the economic level would in turn lead to calls for low interest rates to boost growth and hiring of services. Since the Fed leaders began their campaign, there has been a significant drop in the rate of unemployment though they are still doubtful whether that is a good sign of the health of the economy.  The establishment of more industries in the US marked the fall in the rates of unemployment. One of the main suppliers of employment opportunities is industrialization. Thus, a number of US citizens were able to get ways and means of survival and income. This was good way to contribute to the economy of the US. Unfortunately, despite the fall in unemployment rates, the Fed’s goal of achieving 2% inflation has not been arrived at yet. The highest the Fed has achieved is 1.2 % in the past few years though they are still struggling to ensure that the 2% level is achieved (The Wall Street Journal 3).

The contributions of the Federal Reserve to the economy of the US are also noted down in an article in “The New York Times.” The article articulates that the Fed has in the past few years intensified its drive to stop rising inflation. The reaction of the Fed followed reports in the daily papers in the US that consumer prices were rising year in year out. The move of the Fed also followed the increase in the prime lending rates which financial institutions such as banks capitalized on as a benchmark for loans to their consumers especially those running small businesses. According to the article in the “New York Times”, since the inception of the Federal Reserve, there has been a steady push for the fall in the lending rate by financial institutions. Besides, there has been a push for the rise in the prices of consumer goods and services. This has been the biggest contribution of the Federal Reserve towards the welfare of the American citizens. It is worth noting that the Federal Reserve had to come into agreements with the American government before pushing for increase in lending rates and discount rates on consumer goods. The agreements were made during the Bush era and he as the president of the US at the time was in support of the efforts of the Federal Reserve. The leaders of the Fed came into face-to-face meetings with the US government officials on the need of ensuring an economy that was friendly to both consumers and producers of goods and services. In the long term, a balance of benefit between the two would enhance the economy of the US. This is why the government officials at that time, welcomed the idea or rather the opinion of the Federal Reserve. Nevertheless, at some point, the push for inflation and increase in discount rates became disadvantageous.  The Fed had a number of demands for the government and this caused friction between the two. The government lost its ground and support for the Fed’s ideas. The result of the friction was a significant depreciation in the economy of the US. It is articulated that on the Wall Street, stock prices declined at a great percentage. Besides, there was a significant drop in the bond prices as there was a rise in interest rates in response to the higher Federal funds rate. The dollar that also was believed to strengthen when rates increase also declined. This was a major blow to the economy of the USA (Hershey 3).

According to the “Business Week”, the Federal Reserve in the US has done a lot to ensure that inflation is achieved so as to enhance the economic growth of the US. Besides, the Fed has been struggling to ensure that the lending rates of a number of financial institutions in the US are reduced significantly for the benefit of those who live below a dollar a day.  To begin with, the Federal Reserve had a target of ensuring that the inter-bank lending rate in the US was 0.25%. The aim of this was to ensure that the consumers had friendly interest and lending rates. The focus of the Federal Reserve was a dream-come true, because, on April 4, 2014, the Fed funds closed at 0.27% after trading partnerships from 0.06% to 0.27%. This was as par one of the world’s largest inter-dealer brokers. According to the “Business Week”, the Fed considers the present inflation in the US to be low and thus opts for a rise in inflation to secure economic growth of the US. However, the “Business Week” adds that the rise in inflation should be accompanied by creation of more employment opportunities so that the citizens that live below the poverty should not suffer. The Fed reacted or rather supported the rise in inflation since they viewed that in a few years, the economy of the US would be headed down the drain. This would be a big blow to the world at large, especially to the countries that are major trade partners of the US. Thus, according to the “Business Week”, the Federal Reserve decided to come up with policies that would ensure that a rise in inflation is adopted. Secondly, the Fed came into agreements with the US government concerning the rise in inflation, which would be helpful to the government. One of the ways that the Federal Reserve pushed for the rise in inflation is through advising the Central Bank to give loans to the domestic banks and increasing the interest rates. Through this, the Central Bank will collect so much revenue that will help boost the economy (Aneiro 2).

By pushing for a rise in inflation, on one hand, the Federal Reserve did the right thing. This is because, through an increase in interest rates to domestic banks by the Central Bank of the US, the country would be able to get sufficient income that would help keep its economy moving. Besides, by pushing for an increase in the prices of goods, with exclusion of basic food commodities and energy, the US government would be able to garner enough revenue, which would be a boost to the economy. The Fed did the right thing because they had everybody in mind when pushing for a rise in inflation. This is because they also encouraged the government to create more employment opportunities so that the poor members of the society would be able to get a way of survival (Aneiro 2).

On the other hand, the Federal Reserve did not do the right thing by pushing for a rise in inflation. To start with, when the Central Bank increases its interest rates to the domestic financial institutions, the institutions would be discouraged and withdraw from requesting of loans and this would affect the economy of the US significantly. Furthermore, the domestic financial institutions would increase their interest rates to the common person making it hard for entrepreneurs to expand their businesses, which would in turn or in the end help boost the economy. Additionally, inflation rise would mean the prices of the basic commodities would also go up and this would be disadvantageous to the consumers. It would be worth noting that the Federal Reserve was not right in pushing for a rise in inflation since the implementation of the policy across the US would be biased. That is to say, some goods would be exempted from inflation yet they are supposed to be included. Besides, some officials would misappropriate the revenue collected from the rise in inflation instead of using them with the aim of boosting the economy (Aneiro 2).

According to the “Barrons”, the BlackRock in the New York for financial media hosted a conference. The Federal Reserve that was headed by Janet Yellen, with the aim of pushing for a rise in inflation to boost the country’s economy, held this conference after a policy meeting. The Federal Reserve also pushed for a rise in short-term interest rates for consumers and domestic banks by the Central Bank. It would also be important to note that the Federal Reserve has been shifting focus more indicators of employment rather than just the increasing rates of unemployment. The Fed has been manipulating the money policy in the US such that it has lost its power to help or rather aid the labor market. The Fed leaders believe that the increasing rate of unemployment is disastrous to the economy of the US and thus should be gotten rid of. This would thus be accompanied by a rise in inflation, which would enable the government to get more revenue to run its day-to-day operations. The “Barrons” points out that inflation in the US at present is low. This is the reason why the Fed has taken an initiative to push for rise in the inflation rate. The Fed has done this by asking the Federal government together with the state governments to push for an increase in the prices of basic commodity goods and services with the exception of food and energy products. This would be a major boost for both the federal government and the state governments as they would be able to receive more and sufficient funds to run the economy of the US as a whole. Moreover, in order to achieve its goal of pushing for a rise in inflation, the Fed pushed for the manufacturers, wholesalers and the retailers to increase the prices of their commodities so that they would counter the increased taxation on commodities that would be imposed by the government so as to boost the economy. Increased taxation often results to observable or rather evident inflation.

The “Barrons” considers the act of the Fed of pushing for a rise in inflation as the right thing. This is because a rise in inflation is considered to have a number of advantages. To begin with, one of the primary benefits of inflation is to the investors. This is because long-term indexed Treasury bonds often accompany inflation. These bonds give investors a long-term asset with a fixed long-term real yield that is free from inflation risk. Definitely, all investors often wish for less risks of inflation. Therefore, the Fed has also assured the investors of less risks of inflation making their preference of pushing for a rise in inflation the right thing to do. Secondly, the push for the rise in inflation was the right thing to do by the Fed because it greatly benefited the U.S treasury. Like investors, the U.S. Treasury was bound to benefit greatly from the rise in inflation, which was being pushed for by the Federal Reserve. As a matter of fact, the U.S treasury has benefited a great deal from the inflation risk protection that is often provided by indexed bonds. Besides, as a result of the push by the Fed for a rise in inflation, the US Treasury has been benefiting from savings on its interest expense. The U.S. Treasury is currently considered as one of the leading issuers of nominal bonds. In fact, it bears considerable inflation risk in servicing the debt that it has. If all of the Treasury’s outstanding debt were indexed, the real cost of servicing its debt would not vary inversely with inflation. Indexed bonds would also save the Treasury money by eliminating an inflation risk premium that is often part of the yield on nominal bonds. A risk premium is the difference in the yields of two assets due to differences in the riskiness of the assets. Because investors do not like risk, issuers of riskier assets typically have to pay higher yields to compensate investors for taking on the additional risk. Corporate bonds, for example, pay higher yields than Treasury bonds with comparable maturities since corporate bonds have default risk and Treasury bonds do not. In other words, corporate bonds carry a default risk premium (McCormick 3).

On the other hand, the Federal Reserve’s act of holding conferences to discuss about possible inflation rise in the US can be considered as not being the right thing to do. This is because, inflation rise is considered to be accompanied by a number of disadvantages. For instance, inflation in the US in the past few years has led to increased prices of commodities and services and this has been unaffordable to the poor members of the community. Thus, the Fed should not have pushed for inflation rise. The other disadvantage of inflation is that it leads to increased unemployment because the cost of production and maintenance often increases year in year out yet there is no profitability because customers and consumers are driven away by the high prices of goods and services. Additionally, the Federal Reserve should not have pushed for the rise in inflation as it led to unfavorable balance of payments in companies in the US. That is to say, directors and managers of companies often have or rather put up unfavorable payments for their employees due to a rise in inflation. This is often not favorable in all companies across the US. The other disadvantage of rise in inflation is that it could lead to hoarding and theft of goods from one company to another. A rise in the price of commodities would mean that common persons would not be able to afford such goods. Therefore, they would rather turn to hoarding or theft of goods so as to access such goods easily. Thus, supporting inflation was not a good idea for the Fed (McCormick 3).

According to the “Financial Times”, inflation is considered to be the best thing to do. Actually, the “Financial Times” articulates that the Central Bank in the U.S has played a major role in ensuring that inflation has been achieved. The bank, with the policies and regulations of the Federal government of the US, has been increasing the interest rates of the loans that it has been giving to its customers; that is, the domestic banks in the recent years. In return, the banks have also increased their interest rates to their customers thus prompting small businesspersons and entrepreneurs to increase the prices of their commodities and services. “The Financial Times” adds that the Central Bank in the US has also come up with a policy to make yield gap yawn. This has enabled the government of the US, to have raised revenue collection for running its operations. This has also helped boost the economy of the US (Mackenzie 5).

The Financial Times” considers the rate of inflation to be low. Thus, it pushes for an increase in inflation, though slightly in order to help the government to collect enough funds that would help it run its day-to-day operations. This is why “Thee Financial Times” has also come up with a policy that pushes the Central Bank to increase its interest rates on the domestic financial institutions (Mackenzie 5).

Additionally, according to “The Financial Times”, it was the right thing for the Federal Reserve to push for a rise in inflation. This is because it offered the government with a number of opportunities of revenue collection. This would be very advantageous, as it would help the government in boosting the economy that was almost at the verge of collapse initially. On the other hand, the rise in inflation as supported by “The Financial Times” was not one of the brilliant ideas that came up. This is because inflation would be accompanied by a rise in the prices of goods and services in the market and this would be a great disadvantage to the common man and the poor who live below the poverty line. Thus, apart from pushing for a rise in inflation, the Federal Reserve should have also campaigned or rather pushed for an increase in the rate of employment through creation of more employment opportunities (Mackenzie 5).

Figures showing inflation in the US over the recent years

Fig. 1

Fig. 2

Works Cited

Aneiro, Michael. “BlackRock: As Fed Distorts Short-Term Rates, Better Value In Long Bonds”. Barron’s. 2014, pp 2. Available online at: http://blogs.barrons.com/incomeinvesting/2014/03/20/blackrock-as-fed-distorts-short-term-rates-better-value-in-long-bonds/

Grand Central: As Unemployment Falls, Fed Doves Pivot to Low Inflation Concern. The Wall Street Journal. 2014, pp 2. Available online at: http://blogs.wsj.com/economics/2014/03/24/grand-central-as-unemployment-falls-fed-doves-pivot-to-low-inflation-concern/?KEYWORDS=Federal+Reserve+and+inflation

Hershey, Robert. “Federal Reserve Raises A key Rate to slow inflation”. The New York Times. 1989, pg 3. Available online at: http://www.nytimes.com/1989/02/25/business/federal-reserve-raises-a-key-rate-to-slow-inflation.html

Mackenzie, Michael. “Central bank policy contrast makes yield gap yawn”. The Financial Times. 2014, pp 5. Available online at: http://www.ft.com/intl/cms/s/8fa36678-be5e-11e3-b44a-00144feabdc0,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F8fa36678-be5e-11e3-b44a-00144feabdc0.html%3Fsiteedition%3Dintl&siteedition=intl&_i_referer=http%3A%2F%2Fsearch.ft.com%2Fsearch%3FqueryText%3Dthe%2BFederal%2BReserve%2Band%2Binflation#axzz2yOdOzxwJ

McCormick, Liz. “Fed Funds Open at 0.08%, Within Target Range, According to ICAP”. BusinessWeek. 2014, pp 3. Available online at: http://www.businessweek.com/news/2014-04-07/fed-funds-open-at-0-dot-08-percent-within-target-range-according-to-icap

R.A. “Monetary policy: Low inflation is a choice” The Economist. 2014, pp 6. Available online at: http://www.economist.com/blogs/freeexchange/2014/03/monetary-policy-3#comments