The Power of the Federal Reserve This question is the first question from the li

Question

The Power of the Federal Reserve

This question is the first question from the list of discussion questions listed in Question 4. However, I have expanded on this question to incorporate current news related to the independence of the Federal Reserve. Provide enough information to demonstrate that you understand the role of the Fed in the U.S. economy, use the appropriate economic concepts to describe what the Federal Reserve does to manage the economy.

Question:

a. The Federal Reserve System was established so that it would be independent of the rest of the government. According to the author's of your text, why does the Fed need to protect itself from political pressure?

b. Find a current article related the President's criticism of the Federal Reserve's decision to raise interest rates. Relate the President's objection to the interest rate hike and describe the potential result. What is the Fed's justification for raising interest rates? Are these views contradictory? Is this a good reason for the Federal Reserve's independence?

Provide a web link or citation so that the article read can be read by the instructor.

Explanation / Answer

(a)

One reason is the control of inflation.  When central banks are subjected to political pressure, authorities often pursue excessively expansionary monetary policy in order to lower unemployment in the short run. This produces higher inflation and higher interest rates without lowering unemployment in the long term. ( https://www.cbsnews.com/news/why-the-federal-reserve-needs-to-be-independent/)

As a quasi-independent institution that is shielded from day-to-day political pressures, it can concentrate on the actual business of governing, and on preventing economic calamities. Its existence in this form, which Congressional Republicans have been seeking to undermine, provides an invaluable backstop for the U.S. economy and, indeed, the world economy.

Without independence from the political cycle the central bank would be subject to political pressures, which in turn would impart an inflationary bias to monetary policy. In this area politicians in a democratic society are shortsighted because they are driven by the need to win their next election. This is supported by empirical evidence. A politically insulated central bank is more likely to be concerned with long-run objectives. A variant of the argument for central bank independence is that control of monetary policy is far too important to be put in the hands of politicians. As a group they have repeatedly demonstrated the lack of political will to make difficult economic decisions. (https://www.forbes.com/2009/12/01/grayson-paul-fed-independence-opinions-columnists-thomas-f-cooley.html#7f99a9b827e4)

(b)

https://www.theglobeandmail.com/business/article-trump-not-thrilled-about-fed-decision-to-hike-interest-rates/

After more than six years of record low interest rates that helped the U.S. economy recover from the 2008 financial crisis, the Fed began to slowly raise rates again in December 2015 and has raised them five times since Trump took office in January 2017.

“All those things point to the Fed continuing to raise interest rates and the economy being fairly strong, relative to all the global issues going on: trade wars, the fear in Europe of Brexit without a clear path. I’m surprised the dollar is not higher.”Since that debate the Fed has raised short-term rates six times to an upper level of 2 percent, during which time the unemployment rate dropped a full point to 4 percent in June.

Fed's justification for raising interest rates:-

https://www.bankrate.com/banking/federal-reserve/7-surprising-benefits-of-higher-interest-rates-from-the-federal-reserve/

Tamed inflation

More lending

More interest income for retirees

Stronger dollar to boost purchasing power

Stocks will trade on fundamentals

Would-be homebuyers may get off the fence

Trump’s comments will have much impact on Federal Reserve policy or the markets.

“I don’t think this is indicative of any pending action from the administration that would limit Fed power,” “A good sign of proof there is who he has been naming to the open board spots at the Fed,”

“They are all people with strong independent views on monetary policy and the economy and economic theory ... they are legitimate, verified, bona fide economists and business leaders who are independent.”

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