The US economy has always seen turbulent cyclical effects of inflation and deflation. To gauge the balance between the two experts at the Federal Reserve has always adopted the traditional macroeconomic tool of monetary and fiscal policies. These policies depending on the nature of the situation have helped the country survive some of the toughest economic crises in the American economic history. To name a few, the Great Depression, Inflation of the 1980s stock crash as well as the tech bubble burst during the 1990s. These events have become the cornerstone and a signal for Federal Reserve experts to beware of the coming deflationary or inflationary turn. In the recent years after the crash of the September 11 events, the country once again had seen an economic downfall with many companies going bankrupt while others are forcefully closed due to deteriorating corporate governance. These changing and dynamic economic environments have had great adverse effects on the economy. For this reason the Federal Reserve chief Alan Greenspan and his counterparts have been involved in balancing the economy albeit unsuccessfully.
[...] When there is moderate inflation there is little that the monetary policy can do with drastic measures such as changing the interest rate and implementing open market operations. This is because these measures are long term or rather moderately short term. An announcement of increasing or tightening the economy would bound to create hikes in prices and thereby increase the speed of inflation. This observation is inherent in the recent Testimony to Chairman Greenspan (2005). At the time of the issuance of the policy evidence suggest that economic fundamentals have sustained consumer spendings and increased personal income through net worth gains and credit markets. [...]
[...] The objective of a monetary policy is to keep inflation low and other factors such as consumption, employment and investments high. This is because when interests are low, businesses flourish, there is more employment and when people have more savings they invest more and the cycle goes on. On the other hand when there is a high inflation prices are high, consumption as a result is low, there is little business and profitability to keep the flow of money in the economy to sustain the investment. [...]
[...] What the Federal Reserve need to do now is to make sure that the policy be revised and actions taken to reverse or improve the current scenario before the economy deteriorate further as indicated by the Testimony (2005) "But we should be careful in endeavoring to account for the decline in long-term interest rates by adverting to technical factors in the United States alone because yields and risk spreads have narrowed globally." References Clarida, Richard. Our Post-Bubble World. Wall Street Journal. [...]
[...] It is expected that the Federal Reserve counteract economic problems with available tools and bring the US economy to normalcy. However, in the past and at present too the Federal Reserve has done anything but that. For this reason critics are of the opinion that the recent monetary policy has been a mistake and would result in deterioration of the economy rather than improving it. As Cooper and Madigan reports (2005) "To the Fed's credit, its latest policy statement accomplished what past rate hikes did not: It lifted long-term rates significantly. [...]
[...] This persistence depends critically on parameters governing the speed of diffusion of money through the economy and the degree of financial connectedness." Thus the Federal Reserve through its change in interest rate policy has created a panic in the market which instead of pacifying the investors boosted their reaction to the ongoing open market operations. The monetary policy not only changed the state of the rate of returns but it also affect the liquidity of the economy. Instead of curbing high prices, the policy induce it thereby on the one hand cutting down on consumption and on the other hand increasing long term securities buys. [...]
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