Postings and assignments for students in Econ 3334 at UH
Wednesday, February 27, 2008
Bernanke Talks About Economy
A nice brief article on what Ben Bernanke is thinking about the economy right now. At this point, it should be relatively easy to frame his comments in terms of our IS/LM model.
10 comments:
Anonymous
said...
This article is about the actions the Federal Reserve has taken to lower interest rates over the course of the last year and a signal from its chairman, Ben Bernanke, that rates might be slashed even further in the coming month of March 2008. He maintained that the central Bank's primary emphasis was on economic growth and it would take whatever measures needed to support that and avoid downside risks. However, his statement weakened the dollar's position against the Euro to a record-low ($1.51).
While the Federal Reserve has lowered rates significantly, from 5.25 percent in August 2007 to 3 percent currently, Bernanke said that this had not had a large impact on the housing market as longer-term mortgage rates were not affected by this slashing of rates. The Fed's actions could not make as big a difference as intended because of the increase in risk spreads and the recent changes in longer-term Treasury rates. Hence the economic slowdown the U.S. has been experiencing is becoming more and more expansive in its coverage.
It has hindered consumer spending significantly, and the housing and credit markets have taken their toll on the business sector as well. There are also chances that nonresidential supply will also curtail in the months to follow. And the worst isn't over because the Fed chairman believes there is potential for credit conditions to tighten even further and the deterioration of the housing or labour market to worsen.
As a result, inflation could result in either direction but there is more risk of an upside swing in prices. The prospect of further decreases in interest rates has put pressure on an already-weakened dollar. Gold and oil prices on the other hand are at historically high levels and stocks and bond markets exhibit volatile trading conditions.
The Fed’s main charge is to safeguard the proper functioning of our monetary system (money supply, interest rates, and the economy’s price level). The idea of targeting the money supply to control interest rates, investment, aggregate demand, and ultimately GDP makes sense in the simple world. The world assumes the Fed knows where the demand curve for money is positioned. After all, if its position weren’t known, the Fed couldn’t possible associate specific changes in the money supply to specific changes in the interest rate. Without that specificity, the Fed’s ability to execute policy weakens. What, then can it do? The Fed can choose to target the interest rate, allowing the money supply to take its course.
Once again the Fed may confront problems it didn’t anticipate, that is, it may end up with a money supply it really doesn’t want. But it has no alternative. By choosing the target interest rate, it loses control over the money supply.
You see the Fed’s dilemma, don’t you? It faces an opportunity cost no matter which option it chooses. Even though the Fed loses some control over the interest rate once it targets money supply, the interest rate still moves in the appropriate direction. That is, any increase in the money supply, whatever the demand for money may be, lowers the interest rate. Conversely, any decrease in the target interest rate, whatever the demand for money may be, lowers the money supply. Correct directional movement counts!
The Fed’s countercyclical monetary policy works, whether it targets money supply or interest rates. And since the Fed in not entirely blind to the demand for money, the actual opportunity costs associated with either target may, except in very volatile times, be rather minimal
Econfactor, I agree with what you said about the FED knowing where the demand curve for money is positioned, otherwise the FED would be playing blind. In the same paragraph, you also said that targeting the money supply affects investment. Is this true? Maybe in the long run if the FED is planning to adjust prices while holding income constant. Right? The article talks about Ben Bernanke and his implication that the FED will cut interest rates again. What he is really saying is that the FED plans on selling more Bonds. Doing so will inject more cash into the economy which will increase the money supply (because the reserve ratio has not changed). As the money supply increases, the interest rate falls and, in turn, the downward LM curve shift increases income. So, why does Ben Bernanke want to lower interest rates? Because Bernanke wants to increase financial conditions, which the last five interest rate cuts have failed to do. Just blame it on the housing market slump. He also says that consumer spending (consumption) has slowed significantly. Less consumption means more savings and lower interest rates, according to the Loanable Funds Model. This less consumption causes a downward shift in the IS curve, which lowers interest rates and also lowers income. So, the combination of the two (less consumer spending and Bernanke rate cuts) causes an amplification of the decrease in interest rates, but income is balanced and returned to its original level. What does the article mean when it says that the US central bank remained firmly focused on the risks to growth? Does it mean that the bank is focused on Income/Output? I am thinking that it means the FED is focusing on increasing income instead of prices in terms of the Aggregate Demand model, such as with short run aggregate supply.
Bonehead, you wanted to know if targeting the money supply affects investment, absolutely. I am unable to demonstrate on this site the three graphs of Money Supply, Investment Demand and Aggregate Supply. Visualize the sequence of events that occurs when money supply increases. First, on the loanable funds graph, an increase in money supply from M1 to M2 (→) causes the interest rate to fall in the investment demand graph from I1 to I2 (↓). That fall in the interest rate causes the quantity demanded of investment to increase from I1 to I2 (→). Finally the increase in investment spending shifts the aggregate demand curve from AD1 to AD2 (→), which increases the level of real GDP in this situation. Of course what goes up can come down. By reversing policy on the money supply, the Fed can engineer a decrease in the price level. How? Imagine aggregate demand at AD3. By decreasing the money supply, the interest rate rises, investment falls, and aggregate demand falls, causing the price level to fall. As you see the Fed’s key to controlling GDP and the price level – the heart and soul of countercyclical monetary policy is controlling the money supply. Recall the Fed controls the money supply with three instruments: reserve requirements, the discount rate and open market operations. GDP depends upon aggregate demand, which depends upon investment, which depends upon the interest rate.
As always, financial investors are betting on the direction that the Federal Reserve will go with Monetary Policy. After an “appearance on Capital Hill” Bernanke is apparently, though not admittedly, expected to be “cutting rates” for the 6th time. This is the blame for the increasing yield of the Euro to the USD. This would also cause precious metals, and oil to rise because of their elasticity.
Bernanke explains in layman’s term that it was his intention to soften the blow of the housing market, which according to “The Commerce Department” qtd. by Guha, is currently experiencing the sharpest decline in the last “13 years”.
Bernake also said that he wanted to “offset the credit tightening”. The lowering of the interest rate would lower both the discount rate, and the reserve ratio. This would or should cause an increase in Money Velocity, Currency, and Loanable Funds Market.
The article quotes “Sir John Gieve, deputy governor of the Bank of England, called on international regulators to consider new rules”…. It would be my educated guess that this meeting has much to do with Bernanke’s reference to the banks “muting the impact of Fed easing”.
The banks at this time can either choose to, or choose not to, hold high/low reserves. However, there is a detrimental problem when unreliable banks that are seeking bail outs, and are trying to counterbalance the Central Bank Monetary Policies. The unwillingness of banks to react as deemed necessary causes a deceleration of Loanable Funds, and therefore leads to greater than Expected "unemployment".
Okay, EconFactor I see what you mean. The changes in the money supply by the FED affect the interest rate, which in turn, affects investment because firms are more willing to invest when the interest rate is low than when the interest rate is high. These changes in the money supply translate into GDP increases (or decreases) in the short run, but in the long run prices absorb the shock. This brings up another question that I am unclear about. How do long run aggregate supply price changes affect the money market? I suppose that a change in P will case M/P to go up or down, right? Imagine that the FED increases the money supply, which decreases interest rates and increases GDP. The long run effect will be an increase in prices. Does this change in prices affect the original M/P ratio from the money market? In other words, does the long run increase in P make the money supply M/P smaller and thereby automatically increase interest rates? I hope this makes sense!
This article is about how Ben Bernanke has signaled for the Federal Reserve to cut the United States interest rates once again after the dollar has continued to weaken against the euro. The fed has recently cut rates many times to alleviate the effects from the housing market. Bernanke feels that these rate cuts will only have a very “limited effect in easing overall financial conditions.” In August of last year, the rates were around 5.25 percent and have now already been lowered to three percent. Ben Bernanke believes that doing this is only a short tern fix to the problem. He states that it is “very difficult to lower long-term mortgage rates through Fed action.”
In terms of what we have learned in class is that in order for the Fed to lower the interest rates, they must buy bonds. This puts more money back in to the economy. We can see this in our money market fund. By raising the money supply in the economy, the interest rates will drop. When we transfer this over to the IS/LM graph, The LM curve is the curve being affected by the increase in the money supply. The LM curve is shifted to the right. The interest rate (r) is lowered and the output (y) increases. So, what Ben Bernanke and the Fed are attempting to do by buying more bonds is to increase the money supply, lower the interest rates, and increase output as a means to stimulate the economy.
Bernanke states that consumer spending has decreased. This means there is consumption and more saving being done by the American people. We can see what this does by looking at the loanable funds market. More savings in the loanable funds market means the IS curve will be shifted down to where there are less output and lower interest rates. So these two effects in the IS and LM curves much lower interest rates with out much change in output (y). The changes really depend on how great the changes are the Fed initiates.
This article starts by talking about the value of one euro in terms of U.S. dollars, which is around the $1.51-$1.52 range. Then this article moves towards relating us how Bernanke has cut the fed funds rate from 5.25% to 3%. The real problem comes based on the fact that even though Mr. Bernanke has slashed the fed funds rate, long term rates remain relatively stubborn. This is probably due to creditors’ unwillingness to lend at the equilibrium long term rates, so creditors (banks, foreign central banks, etc…) will demand higher interest rates to compensate for the increase in inflation. Besides, the problem with growth in the housing market is that less price appreciation in housing means less lending because lenders will not want to give mortgages if these houses will be worth less (collateral’s value is decreasing.) In terms of economic concepts, we can use the IS/LM model to understand this a little bit. In other terms, at every interest rate, creditors are less willing to lend even though the Fed has been providing liquidity and lowering the fed funds rate. In other words, lenders are afraid of the high risks associated with some mortgages, so they’ve decided to unilaterally to lend more prudently than before. Also, the IS curve is getting steeper, so monetary policy by Chairman Bernanke will be less effective. From this article I can see that Chairman Bernanke is more worried about growth than inflation. Even though the pressure against the dollar has been high, Bernanke will cut fed funds rate. The US dollar has been declining against the euro and other major currencies so it is a bit worrying that the world’s reserve currency is doing that. My personal opinion is that Bernanke cares less about inflation and more about the credit markets and the economy’s growth path. I think Bernanke should worry more about inflation since commodities are making all time highs, and especially food prices are going up because of this. On the other hand, I think something positive can come out of this credit crisis or “crunch”
This article in the Financial times discusses the actions of the Federal Reserve in its attempt to lower interest rates over the past year and reviews signals made by Ben Bernanke, its chairman. Bernanke indicated that rates would be further reduced in Martch 2008 and stated that the Fed would undergo any action necessary to maintain economic growth and avoid downside risks. The reaction to this statement was a further devaluation of the dollar to $1.51 per euro. The discount rate has fallen drastically over the past year from 5.25% in mid 2007 to 3% at date of the article. Bernanke defended that this large reduction had little effect on the housing market because long term mortgages were not affected by the rate reduction. The Fed's actions were in part hindered due to the fact that the increase in risk spreads and the recent changes in longer-term Treasury rates undermine the rate reduction.
The consequence is that the economic fears spurred by the housing bubble caused by sub-prime mortgages has increased in scope to affect more areas of the economy. This can be readily observed in the fact that consumer spending has decreased and through indicators in the business sector. It is unclear whether these trends will further devalue the dollar or cause a certain degree of deflation, though inflation is more likely when taking into account further monetary and fiscal policy.
This fear of inflation is represented by strong increases in the commodities markets of gold and oil and volatile bond markets. Or perhaps it isn’t: the price of oil has been going up consistently and because of independent indicators regarding supply and demand concerns and stability of production amid a speculative market. The problem with this is that its high price can be used as evidence of high inflation whether this is the case or not which, in turn, can result in high inflation.
The role of the Fed is to maintain the stability and functioning of the monetary system currently in place. In this case, the Fed attempts to control interest rates, investment, aggregate demand and short run GDP by affecting fluctuations in the Money Supply. To limit fluctuations, the Fed engages in monetary policy counter to the movements of the market.
The article “Bernanke signals Fed rate cut” describes the response of Ben Bernanke to the fall of the dollar. The price of the dollar is $1.51 for each euro. Bernanke states that the Fed will respond to the fall of the dollar by supporting growth and issuing insurance on any downside threat. Since the dollar is continuing to fall, it is most likely that the Fed will lower interest rates. So far the Fed has cut interest rates “from 5.25 per cent at the beginning of August to the current level of 3 per cent.” Bernanke announces that it has been complicated for the Fed to bring down long term mortgage rates, but they have been able to offset the reduction of credit. He also points out that the United States is going through “an increasingly broad-based slowdown.” It seems that people are spending less money and the housing and credit markets are also being affected. He adds that the housing market and the labor market may continue to get worse. However, there das been new increases in product prices and the inflation numbers imply a somewhat bigger upside risks to prices. In the meantime, the Commerce Department stated that the sale of new homes has dropped to its slowest rate in almost 13 years.
In the article Bernanke talks about how the fall of the dollar value and the increase in inflation is affecting the US economy. When inflation increases it causes interest rates to decrease. Looking at the IS/LM model when interest rates fall this causes the LM curve to shit down, which in turn causes output to increase. The effects of the decrease in consumer spending can also be viewed in the IS/LM model. The decrease in consumer spending causes savings to raise which also causes interest rates to fall. This reflects what the Fed is trying to do to help fix this problem, lowering interest rates.
In response to this article I believe that what the Fed is trying to do by lowering interest rates should help alleviate the economy. Even though this would be somewhat complicated to do because of the housing market going down so much, in the long run it should work. By lowering the interest rate people will be willing to invest therefore this will bring the value of the dollar back up. I believe the Fed is taking the correct measures to help correct this problem.
The article begins by stating the unpleasant knows that the dollar has fell relative to the Euro. The Euro climbed to $1.51. This occur dafter Bernanke explained that the Federal Reserve is more concerned about the limitations and barriers to growth rather than the recent inflation that has ensued. Bernanke reassure that the Fed will act when need for the better interest of growth. The fed has cut the rate numerous times in the last 9 months. Bernanke confessed that the rate cuts have not affected the housing market all that much. He further explained that the main influence of the trade cut has been the easing of the credit problem. Bernanke further explained that the risk are accelerating from different places. The spending has taken dive. The Housing market and the credit problems seem to have effected business. Construction also is showing signs of decreasing. He speculated that the housing market and labor market can worse even more. Also t that credit situation “may tighten substantially further. The inflation seems likely to that it will get worse also. The “gold and oil set new highs as stocks and treasury bonds traded in volatile manner” and the rate cut has put further pressure on the currency. The article ends by stating that Sir John Gieve has propositions “that would require banks to hold more capital in the boom years of a credit cycle but allow that to drop as the cycle turned down.”
I believe that this will help somewhat. I don't believe that it will elevate all the repercussions of the economic problems. There are too many factors that are involved to stop a recession. A recession will come. What matters is how bad the recession is. With the rates being cut one can only be optimistic. The lowered rate will increase the incentive for people to spend. The increase spending will increase the economy back to what it was before. I think it will take quite a while to come back. Again because of all the factors have to be dealt with. The fed would increase the amount in the money market. This would also decrease the rate. The IS would move to the left. Also the LM would move right. Both of these combined would decrease the rate even further in combination. The drop in rate will increase spending. People will want to spend more once again. The spending will help the economy greatly.
10 comments:
This article is about the actions the Federal Reserve has taken to lower interest rates over the course of the last year and a signal from its chairman, Ben Bernanke, that rates might be slashed even further in the coming month of March 2008. He maintained that the central Bank's primary emphasis was on economic growth and it would take whatever measures needed to support that and avoid downside risks. However, his statement weakened the dollar's position against the Euro to a record-low ($1.51).
While the Federal Reserve has lowered rates significantly, from 5.25 percent in August 2007 to 3 percent currently, Bernanke said that this had not had a large impact on the housing market as longer-term mortgage rates were not affected by this slashing of rates. The Fed's actions could not make as big a difference as intended because of the increase in risk spreads and the recent changes in longer-term Treasury rates. Hence the economic slowdown the U.S. has been experiencing is becoming more and more expansive in its coverage.
It has hindered consumer spending significantly, and the housing and credit markets have taken their toll on the business sector as well. There are also chances that nonresidential supply will also curtail in the months to follow. And the worst isn't over because the Fed chairman believes there is potential for credit conditions to tighten even further and the deterioration of the housing or labour market to worsen.
As a result, inflation could result in either direction but there is more risk of an upside swing in prices. The prospect of further decreases in interest rates has put pressure on an already-weakened dollar. Gold and oil prices on the other hand are at historically high levels and stocks and bond markets exhibit volatile trading conditions.
The Fed’s main charge is to safeguard the proper functioning of our monetary system (money supply, interest rates, and the economy’s price level). The idea of targeting the money supply to control interest rates, investment, aggregate demand, and ultimately GDP makes sense in the simple world. The world assumes the Fed knows where the demand curve for money is positioned. After all, if its position weren’t known, the Fed couldn’t possible associate specific changes in the money supply to specific changes in the interest rate. Without that specificity, the Fed’s ability to execute policy weakens. What, then can it do? The Fed can choose to target the interest rate, allowing the money supply to take its course.
Once again the Fed may confront problems it didn’t anticipate, that is, it may end up with a money supply it really doesn’t want. But it has no alternative. By choosing the target interest rate, it loses control over the money supply.
You see the Fed’s dilemma, don’t you? It faces an opportunity cost no matter which option it chooses. Even though the Fed loses some control over the interest rate once it targets money supply, the interest rate still moves in the appropriate direction. That is, any increase in the money supply, whatever the demand for money may be, lowers the interest rate. Conversely, any decrease in the target interest rate, whatever the demand for money may be, lowers the money supply. Correct directional movement counts!
The Fed’s countercyclical monetary policy works, whether it targets money supply or interest rates. And since the Fed in not entirely blind to the demand for money, the actual opportunity costs associated with either target may, except in very volatile times, be rather minimal
Econfactor, I agree with what you said about the FED knowing where the demand curve for money is positioned, otherwise the FED would be playing blind. In the same paragraph, you also said that targeting the money supply affects investment. Is this true? Maybe in the long run if the FED is planning to adjust prices while holding income constant. Right?
The article talks about Ben Bernanke and his implication that the FED will cut interest rates again. What he is really saying is that the FED plans on selling more Bonds. Doing so will inject more cash into the economy which will increase the money supply (because the reserve ratio has not changed). As the money supply increases, the interest rate falls and, in turn, the downward LM curve shift increases income.
So, why does Ben Bernanke want to lower interest rates? Because Bernanke wants to increase financial conditions, which the last five interest rate cuts have failed to do. Just blame it on the housing market slump.
He also says that consumer spending (consumption) has slowed significantly. Less consumption means more savings and lower interest rates, according to the Loanable Funds Model. This less consumption causes a downward shift in the IS curve, which lowers interest rates and also lowers income. So, the combination of the two (less consumer spending and Bernanke rate cuts) causes an amplification of the decrease in interest rates, but income is balanced and returned to its original level.
What does the article mean when it says that the US central bank remained firmly focused on the risks to growth? Does it mean that the bank is focused on Income/Output? I am thinking that it means the FED is focusing on increasing income instead of prices in terms of the Aggregate Demand model, such as with short run aggregate supply.
Bonehead, you wanted to know if targeting the money supply affects investment, absolutely. I am unable to demonstrate on this site the three graphs of Money Supply, Investment Demand and Aggregate Supply. Visualize the sequence of events that occurs when money supply increases. First, on the loanable funds graph, an increase in money supply from M1 to M2 (→) causes the interest rate to fall in the investment demand graph from I1 to I2 (↓). That fall in the interest rate causes the quantity demanded of investment to increase from I1 to I2 (→). Finally the increase in investment spending shifts the aggregate demand curve from AD1 to AD2 (→), which increases the level of real GDP in this situation. Of course what goes up can come down. By reversing policy on the money supply, the Fed can engineer a decrease in the price level. How? Imagine aggregate demand at AD3. By decreasing the money supply, the interest rate rises, investment falls, and aggregate demand falls, causing the price level to fall. As you see the Fed’s key to controlling GDP and the price level – the heart and soul of countercyclical monetary policy is controlling the money supply. Recall the Fed controls the money supply with three instruments: reserve requirements, the discount rate and open market operations. GDP depends upon aggregate demand, which depends upon investment, which depends upon the interest rate.
Summary:Bernanke Signals Fed Rate
By: Krishna Guha;Washington
Published: February 27 2008
As always, financial investors are betting on the direction that the Federal Reserve will go with Monetary Policy. After an “appearance on Capital Hill” Bernanke is apparently, though not admittedly, expected to be “cutting rates” for the 6th time. This is the blame for the increasing yield of the Euro to the USD. This would also cause precious metals, and oil to rise because of their elasticity.
Bernanke explains in layman’s term that it was his intention to soften the blow of the housing market, which according to “The Commerce Department” qtd. by Guha, is currently experiencing the sharpest decline in the last “13 years”.
Bernake also said that he wanted to “offset the credit tightening”. The lowering of the interest rate would lower both the discount rate, and the reserve ratio. This would or should cause an increase in Money Velocity, Currency, and Loanable Funds Market.
The article quotes “Sir John Gieve, deputy governor of the Bank of England, called on international regulators to consider new rules”…. It would be my educated guess that this meeting has much to do with Bernanke’s reference to the banks “muting the impact of Fed easing”.
The banks at this time can either choose to, or choose not to, hold high/low reserves. However, there is a detrimental problem when unreliable banks that are seeking bail outs, and are trying to counterbalance the Central Bank Monetary Policies. The unwillingness of banks to react as deemed necessary causes a deceleration of Loanable Funds, and therefore leads to greater than Expected "unemployment".
Jason Brooks
Okay, EconFactor I see what you mean. The changes in the money supply by the FED affect the interest rate, which in turn, affects investment because firms are more willing to invest when the interest rate is low than when the interest rate is high. These changes in the money supply translate into GDP increases (or decreases) in the short run, but in the long run prices absorb the shock. This brings up another question that I am unclear about. How do long run aggregate supply price changes affect the money market? I suppose that a change in P will case M/P to go up or down, right? Imagine that the FED increases the money supply, which decreases interest rates and increases GDP. The long run effect will be an increase in prices. Does this change in prices affect the original M/P ratio from the money market? In other words, does the long run increase in P make the money supply M/P smaller and thereby automatically increase interest rates? I hope this makes sense!
This article is about how Ben Bernanke has signaled for the Federal Reserve to cut the United States interest rates once again after the dollar has continued to weaken against the euro. The fed has recently cut rates many times to alleviate the effects from the housing market. Bernanke feels that these rate cuts will only have a very “limited effect in easing overall financial conditions.” In August of last year, the rates were around 5.25 percent and have now already been lowered to three percent. Ben Bernanke believes that doing this is only a short tern fix to the problem. He states that it is “very difficult to lower long-term mortgage rates through Fed action.”
In terms of what we have learned in class is that in order for the Fed to lower the interest rates, they must buy bonds. This puts more money back in to the economy. We can see this in our money market fund. By raising the money supply in the economy, the interest rates will drop. When we transfer this over to the IS/LM graph, The LM curve is the curve being affected by the increase in the money supply. The LM curve is shifted to the right. The interest rate (r) is lowered and the output (y) increases. So, what Ben Bernanke and the Fed are attempting to do by buying more bonds is to increase the money supply, lower the interest rates, and increase output as a means to stimulate the economy.
Bernanke states that consumer spending has decreased. This means there is consumption and more saving being done by the American people. We can see what this does by looking at the loanable funds market. More savings in the loanable funds market means the IS curve will be shifted down to where there are less output and lower interest rates. So these two effects in the IS and LM curves much lower interest rates with out much change in output (y). The changes really depend on how great the changes are the Fed initiates.
This article starts by talking about the value of one euro in terms of U.S. dollars, which is around the $1.51-$1.52 range. Then this article moves towards relating us how Bernanke has cut the fed funds rate from 5.25% to 3%.
The real problem comes based on the fact that even though Mr. Bernanke has slashed the fed funds rate, long term rates remain relatively stubborn. This is probably due to creditors’ unwillingness to lend at the equilibrium long term rates, so creditors (banks, foreign central banks, etc…) will demand higher interest rates to compensate for the increase in inflation. Besides, the problem with growth in the housing market is that less price appreciation in housing means less lending because lenders will not want to give mortgages if these houses will be worth less (collateral’s value is decreasing.)
In terms of economic concepts, we can use the IS/LM model to understand this a little bit. In other terms, at every interest rate, creditors are less willing to lend even though the Fed has been providing liquidity and lowering the fed funds rate. In other words, lenders are afraid of the high risks associated with some mortgages, so they’ve decided to unilaterally to lend more prudently than before. Also, the IS curve is getting steeper, so monetary policy by Chairman Bernanke will be less effective.
From this article I can see that Chairman Bernanke is more worried about growth than inflation. Even though the pressure against the dollar has been high, Bernanke will cut fed funds rate.
The US dollar has been declining against the euro and other major currencies so it is a bit worrying that the world’s reserve currency is doing that.
My personal opinion is that Bernanke cares less about inflation and more about the credit markets and the economy’s growth path. I think Bernanke should worry more about inflation since commodities are making all time highs, and especially food prices are going up because of this. On the other hand, I think something positive can come out of this credit crisis or “crunch”
This article in the Financial times discusses the actions of the Federal Reserve in its attempt to lower interest rates over the past year and reviews signals made by Ben Bernanke, its chairman. Bernanke indicated that rates would be further reduced in Martch 2008 and stated that the Fed would undergo any action necessary to maintain economic growth and avoid downside risks. The reaction to this statement was a further devaluation of the dollar to $1.51 per euro. The discount rate has fallen drastically over the past year from 5.25% in mid 2007 to 3% at date of the article. Bernanke defended that this large reduction had little effect on the housing market because long term mortgages were not affected by the rate reduction. The Fed's actions were in part hindered due to the fact that the increase in risk spreads and the recent changes in longer-term Treasury rates undermine the rate reduction.
The consequence is that the economic fears spurred by the housing bubble caused by sub-prime mortgages has increased in scope to affect more areas of the economy. This can be readily observed in the fact that consumer spending has decreased and through indicators in the business sector. It is unclear whether these trends will further devalue the dollar or cause a certain degree of deflation, though inflation is more likely when taking into account further monetary and fiscal policy.
This fear of inflation is represented by strong increases in the commodities markets of gold and oil and volatile bond markets. Or perhaps it isn’t: the price of oil has been going up consistently and because of independent indicators regarding supply and demand concerns and stability of production amid a speculative market. The problem with this is that its high price can be used as evidence of high inflation whether this is the case or not which, in turn, can result in high inflation.
The role of the Fed is to maintain the stability and functioning of the monetary system currently in place. In this case, the Fed attempts to control interest rates, investment, aggregate demand and short run GDP by affecting fluctuations in the Money Supply. To limit fluctuations, the Fed engages in monetary policy counter to the movements of the market.
The article “Bernanke signals Fed rate cut” describes the response of Ben Bernanke to the fall of the dollar. The price of the dollar is $1.51 for each euro. Bernanke states that the Fed will respond to the fall of the dollar by supporting growth and issuing insurance on any downside threat. Since the dollar is continuing to fall, it is most likely that the Fed will lower interest rates. So far the Fed has cut interest rates “from 5.25 per cent at the beginning of August to the current level of 3 per cent.” Bernanke announces that it has been complicated for the Fed to bring down long term mortgage rates, but they have been able to offset the reduction of credit. He also points out that the United States is going through “an increasingly broad-based slowdown.” It seems that people are spending less money and the housing and credit markets are also being affected. He adds that the housing market and the labor market may continue to get worse. However, there das been new increases in product prices and the inflation numbers imply a somewhat bigger upside risks to prices. In the meantime, the Commerce Department stated that the sale of new homes has dropped to its slowest rate in almost 13 years.
In the article Bernanke talks about how the fall of the dollar value and the increase in inflation is affecting the US economy. When inflation increases it causes interest rates to decrease. Looking at the IS/LM model when interest rates fall this causes the LM curve to shit down, which in turn causes output to increase. The effects of the decrease in consumer spending can also be viewed in the IS/LM model. The decrease in consumer spending causes savings to raise which also causes interest rates to fall. This reflects what the Fed is trying to do to help fix this problem, lowering interest rates.
In response to this article I believe that what the Fed is trying to do by lowering interest rates should help alleviate the economy. Even though this would be somewhat complicated to do because of the housing market going down so much, in the long run it should work. By lowering the interest rate people will be willing to invest therefore this will bring the value of the dollar back up. I believe the Fed is taking the correct measures to help correct this problem.
The article begins by stating the unpleasant knows that the dollar has fell relative to the Euro. The Euro climbed to $1.51. This occur dafter Bernanke explained that the Federal Reserve is more concerned about the limitations and barriers to growth rather than the recent inflation that has ensued. Bernanke reassure that the Fed will act when need for the better interest of growth. The fed has cut the rate numerous times in the last 9 months. Bernanke confessed that the rate cuts have not affected the housing market all that much. He further explained that the main influence of the trade cut has been the easing of the credit problem. Bernanke further explained that the risk are accelerating from different places. The spending has taken dive. The Housing market and the credit problems seem to have effected business. Construction also is showing signs of decreasing. He speculated that the housing market and labor market can worse even more. Also t that credit situation “may tighten substantially further. The inflation seems likely to that it will get worse also. The “gold and oil set new highs as stocks and treasury bonds traded in volatile manner” and the rate cut has put further pressure on the currency. The article ends by stating that Sir John Gieve has propositions “that would require banks to hold more capital in the boom years of a credit cycle but allow that to drop as the cycle turned down.”
I believe that this will help somewhat. I don't believe that it will elevate all the repercussions of the economic problems. There are too many factors that are involved to stop a recession. A recession will come. What matters is how bad the recession is. With the rates being cut one can only be optimistic. The lowered rate will increase the incentive for people to spend. The increase spending will increase the economy back to what it was before. I think it will take quite a while to come back. Again because of all the factors have to be dealt with.
The fed would increase the amount in the money market. This would also decrease the rate. The IS would move to the left. Also the LM would move right. Both of these combined would decrease the rate even further in combination. The drop in rate will increase spending. People will want to spend more once again. The spending will help the economy greatly.
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