BRIEFING ON INFLATION, UNEMPLOYMENT AND THE FED
Briefingon Inflation, Unemployment and the Fed
Table of Contents
Backgroundof the Concepts 3
TheRole of Fed 4
HowFed Works 4
Unemploymentand inflation are challenges that were aggravated by the recent2008-2009 financial downturn. Although various economic measures havebeen implemented to lessen the inflation rates and redundancy levels,the adopted approaches have to be re-examined in order to adoptworkable solutions for the future. The FederalReserve (“the Fed”) has an imminent role in controlling­unemployment and inflation. There are significant background conceptsthat will come up in this debate.
Backgroundof the Concepts
Afundamental role of Economists is to determine if the economy of anation is shrinking in size or expanding. As a result, in order toestimate the decline or upsurge in economic performance, the use ofthe Real GDP is imperative. In general Real GDP can be defined as thetotal cost of all the services and goods produced or manufactured ina certain period or year, adjusted in order to remove the impact ofthe changes in prices (Saylor Academy, 2012).
Akey aspect about the real GDP is that only the final services andgoods are incorporated in the GDP (Saylor Academy, 2012). A case inpoint is a scenario where a bread manufacturer uses flour to producethe product. If the cost of the flour and the cost of the bread isestimated, then the value of the flour would increase, which createsan overstating of the cost of production. Only the final goodproduced at a certain time is counted.
Inflationcan be described as an escalation in the cost of living due to anincrease in the general prices of services and goods. Measuringinflation has often been a difficult concept However, economists use the CPI which is the measure of price changes in services andgoods in comparison to the PPI index which is the Producer PriceIndexes also known as the changes in prices that are made by thesellers of the products. In the event that prices decline thendeflation occurs which is the opposite of inflation (Pettinger,2004).
It is essential to take note that the negative implication ofinflation is that it causes an increase in unemployment. A challengeis presented in the sense that wages cannot be reduced. Althoughemployees are usually against wage reduction, a negative effect isthat companies cannot employ more workers therefore increasing thelevel of unemployment (Pettinger, 2004).
The rate at which people in the economy are without employment or jobopportunities. It is possible to reduce the rate unemployment throughthe application the right economic appraoches.
TheConcepts of Aggregate Supply and Aggregate Demand
Economistsapply the aggregate demand and aggregate supply model to estimate therise and fall in the economy as a whole. The concept of aggregatesupply can be defined as the quantity of services and goods thatfirms manufacture and are willing to sell at a certain period oftime. Aggregate demand on the other hand, highlights the quantity ofservices and goods that firms, customers abroad, households and thegovernment are willing to purchase at every price level. The figure1.0 below provides a clear description of the application. Ashighlighted by the model, the quantity of the output and the priceare adjusted to create a balance (equilibrium) in the aggregatesupply and aggregate demand.
In the event that the actual GDP shiftsbeyond the credible GDP then it can be stated that the economy is experiencing what is referred to as a positive output gap. However, in a scenario wherethe Aggregate demand surpasses the set capacity, scarcity isexperienced and inflation occurs due to an increase in prices, theincrease is known as the inflation gap.
Thereare scenarios where the actual GDP shifts beneath the credible GDP,this leads to a negative gap also known as a recession. During suchperiods, the unemployment rate increases which results to a declinedpressure on the level of inflation which is identified as therecessionary gap. Figure 2.0 demonstrates the two concepts.
TheRoles of Fed
Akey mandate of the agency is to formulate the monetary policy of thenation by setting the credit and monitory environment in order tocreate stable prices, to develop a maximum level of employment and abalance in the long- term interest rates (Saylor Academy, 2011).
Anotherobligation is to regulate and supervise banking institutions toascertain the soundness and safety of the banking industry and alsoto safeguard the credit of customers.
Fedalso seeks to ensure that there is stability in the financial systemand prevents any risks that may emerge from the financial markers
Anotherkey mandate is to offer financial services to the government,depository organizations and foreign institution. In addition, theagency manages the national payment system (Saylor Academy, 2011).
WhatTools Fed Uses to Achieve Its Goals
FedUses the Following Tools to Achieve its Objectives
Open market operations—the buying or sale of securities, mainly those from the U.S. Treasury securities. The open market operations determine the balances held by depository institutions.
Discount window lending— the approach involves the provision of credit to depository institutions which is done through lending programs.
Contractual clearing balances— the amount that Federal Reserve Bank holds for depository institutions including any recommended reserve balances.
Reserve requirements— a certain proportion of deposits that bank institutions must store as reserve in terms of cash or other means of payment.
WhatTakes Place When the Fed Pursues an Expansionary or ContractionaryPolicy
WhenFed pursues an expansionary or contractionary policy, their course ofaction will be debated by Congress, amends are then made afterintense consultations with Fed.
Anarticle published by The Economist (2016) discloses the fundamentaltask undertaken by Fed which is the setting of interest rates. Therate setting committee is usually charged with this task. A case inpoint is in December 2015. In this instance, the Fed increasedinterest rates to 0.25% and 0.5% from an amount close zero, wherethey stood since 2008. During this period, the committee tasked withrate setting projected four more rises in 2016. Just after theincrease, the stock markets dropped due to panic that Chinese growthwould slow down the global economy. Some companies, for example S andP 500 went down by 11% at the beginning of the year, until the monthof February. There was also the likelihood of a recession. AlthoughFed predicted that the year 2016 will experience a four time increasein interest rates, economists have projected a two time increase inrates.
Anotherfundamental role of Fed is the reduction of the unemployment rate. By adjusting the rate of federal funds, the agency influences theemployment rate. For instance, when the rates reduce, organizationsborrow funds at a cheaper rate and are willing to boost productionand even higher more employees. Fed’s Chairperson, Janet Yellen,disclosed that one of the greatest objectives of the agency is toattain full employment. Most significantly in the year 2016, theunemployment rate continues to reduce. Payrolls have also improved by215, 000 an estimate that is beyond the projected rate of employmentthat is required to moderate the economy. The rate of labour forceparticipation, which had plunged, is currently on the rise (TheEconomist, 2016).
Fed operates by benchmarking, which involves comparing the existinginterest rates with the condition of the global economy. In March2016, Fed disclosed that it would raise interest rates in the nearfuture. The decision was mainly influenced by the weakness in theglobal economy. At the beginning of 2016, Fed begun to increase itsbenchmark rate to about 1%. Most of the officials supported this movedue to the fact that financial conditions were constrained, as aresult of the state of the global economy (Appelbaum, 2016).
Appelbaum,B. (2016). Fed Slows Down on Plans to Pursue Interest RateIncreases. TheNew York Times.
Pettinger,T. (2004). Inflation.Economics.
SaylorAcademy. (2012). Overviewof the Federal Reserve.Retrieved fromhttp://www.saylor.org/site/wp-content/uploads/2012/09/SAYLOR.ORG-ECON302-Chapter-1.pdf
SaylorAcademy. (2011).Overviewof the Federal Reserve System The Federal Reserve Board. Saylor Academy.
TheEconomist. (2016). DC hold’em, How long will the Fed keep ratessteady? TheEconomist.