Monetary Policy Action Effect on Economy Essay

The Federal Reserve’s decision in August 2006 to leave interest rates unchanged underscores the degree of uncertainty in the U. S. economic establishment about the near future. For the past two years monetary policy more or less went on in a straightforward manner; the Fed’s policymakers raised their benchmark federal funds rate by a quarter point at 17 successive meetings as the economy emerged from a period when deflation looked a real threat back to a more normal world of strong growth and steadily rising inflation. Currently, there are, broadly, three views among economists about what happens next. The first, an optimistic assessment in keeping with recent economic history, favors the â€Å"soft landing† approach. The Fed has raised rates by just enough, according to this view, to restrain growth so as to squash inflation back into its box. The Fed funds rate now stands at 5. 25 per cent; with inflation in the 2. 5 per cent to three per cent range, that represents a real rate of about 2. 5 per cent, a reasonable amount of restraint. On this view, the Fed probably won’t have to do anything more on interest rates for the foreseeable future — just watch in satisfaction as the economy slows to its desired pace. The second view is pessimistic and fearful. It believes that the Fed has already gone too far. The housing market, the driver of so much demand for the global economy, is off sharply. Many Americans are desperately refinancing short-term adjustable rate mortgages they took out three years ago when rates were at historic lows. They are finding themselves with thousands of dollars less a year in disposable income than they had last year. Debt levels are sky high and the savings rate is negative. As consumers rebuild their tattered balance sheets, they will cut spending sharply, with catastrophic consequences. High oil prices are making matters even worse. On this assessment, the next move in rates will be down, if the Fed is to avert a really unpleasant shock to the economy. Some economists think the fed funds will be below 4. 5 per cent by the middle of next year as Ben Bernanke, the Fed chairman, struggles to avert a full-blown recession. The third view might be called fatalistic realism. It accepts the second proposition that, on current policies, a recession is coming, but insists that it is absolutely necessary and it says that the Fed, far from pressing on the economic accelerator, should keep its foot on the brake. For the Fed, and the world, a recession may be the price that now needs to be paid to avert a longer-term catastrophe (Baker).