Monetary policy is the action taken by the Federal Reserve to expand or contract the money supply and influence interest rates.
What are the current unemployment and inflation rates? How has the Fed redefined its targets for inflation and unemployment, and how do current conditions compare to those targets?
As the top advisor to the chair of the Federal Reserve, define contractionary and expansionary monetary policies and explain which you advise the Fed to pursue today—given the inflation and unemployment targets versus the current rates.
Inflation - Winners and Losers
We often hear of inflation characterized as a bad thing, but Meyer describes both winners and losers from inflation. Give an example of one way in which you would win from unexpected inflation and an example of one way in which you would lose from unexpected inflation.
Before answering these questions, review this Summary of New Fed Monetary Policies. You may consult other sources as well and include them in your bibliography.
Full Answer Section
Given the inflation and unemployment targets versus the current rates, I would advise the Fed to pursue contractionary monetary policy. This would help to reduce inflation and bring it closer to the Fed's target.
Here are some examples of winners and losers from inflation:
- Winners:
- Borrowers: When inflation rises, the value of debt decreases. This is because the amount of money that needs to be repaid in the future is worth less due to inflation.
- Exporters: When inflation rises in one country but remains low in other countries, the exports of that country become more competitive. This is because the prices of the exports are lower in terms of the currencies of other countries.
- Asset holders: When inflation rises, the prices of assets such as stocks and real estate tend to rise as well. This is because assets are a store of value and people are willing to pay more for them when inflation is high.
- Losers:
- Lenders: When inflation rises, the value of the money that is lent out decreases. This is because the amount of money that is repaid in the future is worth less due to inflation.
- Importers: When inflation rises in one country but remains low in other countries, the imports of that country become more expensive. This is because the prices of the imports are higher in terms of the currency of that country.
- Fixed-income earners: When inflation rises, the purchasing power of fixed-income payments such as pensions and social security benefits decreases. This is because the payments are fixed in nominal terms and do not rise with inflation.
Inflation can be a complex issue with both winners and losers. It is important to understand the different impacts of inflation in order to make informed decisions about how to manage it.
Sources:
- Summary of New Fed Monetary Policies: https://www.federalreserve.gov/newsevents/pressreleases/monetary20220126a.htm
- The Effects of Inflation: https://www.investopedia.com/terms/i/inflation.asp
Sample Answer
The current unemployment rate in the United States is 3.6%. The current inflation rate is 8.6%. The Fed has redefined its targets for inflation and unemployment to be 2% and 4%, respectively. Current conditions are above the Fed's targets.
Contractionary monetary policy is a policy that aims to reduce the money supply and raise interest rates. This can be done by selling government bonds, raising the reserve requirement, or increasing the discount rate. Expansionary monetary policy is a policy that aims to increase the money supply and lower interest rates. This can be done by buying government bonds, lowering the reserve requirement, or decreasing the discount rate.