Evaluate Federal Reserve’s role in growing interest rates
The future of the United States economy is unpredictable, and its savior lies in the hands of the Federal Reserve. The Federal Reserve, also known as “The Fed,” is the watchdog of the U.S. economy; its purpose is to oversee and protect the U.S. economy. Dangers exist just as threatening as enemies like the Great Recession and the Great Depression that have occurred in the history of our economy. Although not formally known as the “Central Bank of the United States,” it serves the exact same purpose and is deliberately established free and separate of Washington’s grid of politics. Founded by Congress in 1913, its role in banking and the economy has expanded and has been revolutionized.
The Fed has three main functions, which include an effective payments system, supervising and regulating banking operations and conducting monetary policy. , the Fed’s mandate is "to promote sustainable growth, high levels of employment, stability of prices and levels to help preserve the purchasing power of the dollar and moderate long-term interest rates.” In other words, the Fed's job is to foster a sound banking system and a healthy economy. So what now?
The Federal Reserve raises or lowers interest rates through its regularly scheduled Federal Open Market Committee, the monetary policy arm of the Federal Reserve Banking System. The FOMC sets a target for the federal funds rate after reviewing current economic data. Most recently, Fed Chair Janet Yellen began working toward ending the quantitative easing program. Quantitative easing is an unconventional monetary policy, in which a central bank purchases government securities or other securities from the market, in order to lower interest rates and increase the money supply. QE is an unconventional form of monetary policy where a Central Bank creates new money electronically to buy financial assets, like government bonds. This process aims to directly increase private sector spending in the economy and return inflation to target, which in the U.S. is roughly 2 percent.
Now, whenever interest rates are rising or falling, you commonly hear about the “federal funds rate.” This is the rate that banks use to lend each other money. Higher interest rates usually means higher borrowing costs and people will eventually start spending less in a variety of ways.
A growth increase presumably leads to an unemployment decrease, which further leads to an inflation increase, which then calls for an increase in interest rates.
The rise in interest rates also leads to less investment as it costs firms more to borrow — this affects unemployment. The way it does so, for example, is reducing consumption (as mortgage repayments increase), making borrowing money from banks cost more, and as mentioned aggregately ‘less consumption.’ From the firm’s perspective, there is less demand for workers.
The U.S. has been the leading world economy for many years, arguably since 1880. In terms of innovation and business, the U.S. has always been a leader, and since the turn of the 19th century, it has been recognized as a world leader. The problem Americans face now is continuing that legacy. How interest rates can influence long-run aggregate economics seems like a gamble to the most experienced Janet Yellen. As far as economics has grown thus far, there is much more yet to be discovered. The modern world is in its teens and currently experimenting with new tools in every sector of the economy. Whether it be the healthcare systems, Brexit, Venezuelan extreme inflation or dealing with Greece’s debt repayment, the world is figuring it all out through the same — maybe more sophisticated — trial and error. Higher interest rates will bring about more investment in the American economy from abroad. My reasoning does not have to do with the U.S. and in fact may clash with the views of Janet Yellen. , Yellen mentioned that she saw little evidence of soft inflation in the United States as a result of change in the global economy. I agree with Yellen’s statement. I very much believe that because the rest of the world is a volatile, chemical combustion, the U.S. appears extremely stable under this context. We are not dealing with the trade deals, rip-ups and rewrites between the European Union and Britain, nor hyper-inflation in some developing countries. In fact, we aren’t even dealing with coups or mass riots in our streets, as most people in America trust the process and have trusted in democracy and capitalism for a long time. Our latest fear is how to approach our future and whether we should continue to raise interest rates or how it will impact our growth of inflation or whether there is more to the picture that we are not seeing.
The most obvious concern is the weakness of inflation, which has remained below the Fed’s 2 percent annual target since the financial crisis. The unemployment rate stands at around 4 percent, and labor force participation has stabilized. While wage growth remains weak by historical standards, Yellen said that it was mostly the result of slow growth in productivity, meaning that it will, in time, correct and that wages should increase.
As far as the recent tax cuts, Yellen said the prospect of tax cuts or other changes in domestic fiscal policy has not influenced the Fed’s monetary policy plans at this point. She stated,“We’re uncertain about the size, timing and composition of changes that will actually be put into effect,” according to the same Oct. 15 New York Times article. Meanwhile, Republicans often say the total tax cut will be $5.5 trillion over 10 years, and the reality is most of the reductions are paid for by raising taxes elsewhere. The tax cuts that are financed by taking on new debt add up to $1.5 trillion. This may have an impact elsewhere and not in productivity, as it may not transfer directly to consumer spending or vice versa and therefore lead to the growth that Janet Yellen and the board have been looking for. To be able to watch inflation rise with the growth of the economy is a natural occurrence; however, part of the Fed’s plan is to monitor this rate to a max of 2 percent so that the Fed will be able to control the speed of the growth of the economy and relax it from too much heat. In simple words, as the economy grows faster, so does the money that is pumping into the system. This requires a cool down system that monitors price levels and maintains stability in a massive economy — in fact, the largest, with a GDP of $18.57 trillion dollars. There is a large collar for this domestic animal, and we must ensure the string won’t rip again.