Week In Review December 2nd**
Key Terms:
Commodity Money: Money that is backed by a single commodity (gold, silver, rice, etc.).
Fiat Money: Money whose value is backed by nothing. It is only backed by the market’s confidence in the money supply.
Inflation: It is the reduction in the buying power of money
Federal Funds Rate: It is the rate at which the Federal Reserve loans overnight money to banks
Central Banking:
· The Federal Reserve was created in 1913 with the dual mandate of controlling inflation and unemployment.
o It does so by manipulating the money supply.
· It is the bank that controls the monetary supply and while not always run by the government (and independent from the federal government in the U.S.) it has the power vested by the federal government to manipulate the economy through the money supply.
Quantitative Easing: Quantitative easing is the acquisition from banks for cash of bonds and assets by a central bank. It is meant to increase the amount of money in the system, thereby increasing the amount of lending, and stimulating the economy. The Federal Reserve did 3 rounds of quantitative easing during the great recession.
Monetary Policy: It is policy that involves manipulating the money supply by raising and lower the federal funds rate and by the central bank buying and selling bonds and assets. It is used to control inflation and unemployment.
Fiscal Policy: Manipulation of the economy by federal government spending and taxation. To stimulate the economy, the federal government can spend on public works projects and in other areas to increase hiring and the federal government can slow down the economy by saving and running a surplus.
Natural Rate of Unemployment: It is the rate of unemployment that the Federal Reserve deems natural which means it is a necessary and compulsory part of the economy. It is also the Federal Reserve target unemployment rate and it is currently 5%.
Current Events:
With Donald Trump’s proposed infrastructure spending plan there is significant speculation that this could expand the economy a drive up inflation. If this happens it is highly possible that the Federal Reserve would raise interest rates to cool down inflation however this could be seen by Donald Trump as an attack on the economic “boom” he is attempting to create. This could continue the already tense relationship between President Elect Trump and Chairman Yellen. This relationship has been characterized by Trump calling Yellen’s interest rates political and intended to create a economy that falsely appears successful. While it is possible that Yellen will keep interest rates somewhat low to repair some of the economic damage caused by the rate recession, only time will tell how their relationship shapes up in the end.
Donald Trump has a giant opportunity over the next 2 years to reshape the Federal Reserve. With two vacancies already open on the Federal Reserve board of governors. his has opportunities to make major appointments including the vice-chair of supervision which oversees the nations largest banks. Furthermore, Chairman Yellen and Vice-Chairman Fischer’s terms both expire in 2018 and it is expected the Gov. Tarullo will retire in the coming year. This give Donald Trump the enormous opportunity to fill up to 5 of the 7 seats on the board of governors and shift federal policy in the deregulatory and conservative direction. Considering, his already favorable appointments towards banks including appointing a former CEO of Goldman Sachs and his Secretary of the Treasury, his is likely to appoint conservative and pro-deregulation individuals to those posts. This could lead to the rollback of some of what the Federal Reserve has done over the last 8 years and could allow Donald Trump to make good on his promise to the American people of doing something about interest rates that he sees as creating a bubble while being dangerously too low.
Takeaways:
The Federal Reserve has enormous power to manipulate the U.S. economy and thereby the world economy. The dollar is the currency of the world. It is trusted, held, and accepted everywhere thanks to the stability the Federal Reserve’s economic policy has created. We learned the central banks can maintain or destroy the economy and it is very easy to do the latter. Look at Zimbabwe. In this regard, I would say that one could argue that Janet Yellen is the most powerful person in the world with control (albeit with the consent of 6 other individuals) over the nation’s economy and the world’s money supply.
The Federal Reserve has used its power to buy trillions of dollars of assets including toxic mortgage backed securities and Treasury Bonds. This highly interventionist Federal Reserve in my opinion saved the U.S. economy by stepping in to aggressively push lending during the Great Recession. While others may argue against that, the massive Federal Reserve balance sheet and current policy makes it a highly powerful institution. With trillions of dollars in U.S. treasury bonds it has a great stabilizing effect on our bond market and interest rates due to the vested interest the central bank has in the solvency of those bonds. Furthermore, this balance sheet grants the Federal Reserve enormous power to either sell or buy assets to either cool or warm up the economy. This week I have learned that Yellen has lead a highly interventionist Federal Reserve that has used novel tactics to push the U.S. economy out of recession. The effectiveness of manipulating the federal funds rate has fallen do the every growing more complex lending market but Yellen has found new tools including Quantitative Easing to move the economy back to the central bank’s target. I approve of these techniques as they have a stabilizing effect on the market and the economy. Imagine what could have happened in the Federal Reserve hadn’t stepped in or removed hundreds of billions of dollars of toxic assets from the market place. I suspect it would have ended like the Great Depression where under a similar economic situation, the federal government failed to step in and unemployment surged above 20%. While this is all speculation, this unit has given me new respect for the power of the Federal Reserve and its position as the regulator of the economy.
*By Adolfo but posted by Grace as Adolfo does not have blog access.
** blog post up late because Grace was being a dufus and left it in draft and forgot to hit publish (sorry Adolfo)
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