Monetary Policy Of Federal Reserve To Fight Against Unemployment Rate

Summary

Describe about the Monetary Policy of Federal Reserve to Fight against Unemployment Rate?

This assignment is based on the “Houston Business Journal” written by Kent Hoover on 17^th Jun, 2015 (as given in the appendix portion). The title of the news journal is “Fed wants to see more jobs before it raises interest rates”.  This newspaper journal is indicating the monetary policy of Federal Reserve regarding interest rate and employment. This relationship between interest rate and employment also represents the relationship between inflation and unemployment rate, as there is a deep relationship between interest rate and price-level. So, the following assignment has discussed about the current trend of inflation and unemployment rate of U.S. and its impact on the economy. It has also discussed the policy of Federal Reserve (the central bank of U.S.) regarding inflation and unemployment rate.

U.S. is the most developed country in this world. But, the economy of U.S. was badly affected by the global financial crisis of 2000s. Due to this financial crisis many people lost their jobs which led to an increase in unemployment rate. Federal Reserve is trying to reduce this unemployment rate, by monitoring the interest rate policy (Beckworth 2012).

According to the selected news paper journal, the Federal Reserve is monitoring the interest rate to increase more job rate. This monetary policy of Federal Reserve depends on the macroeconomic theory of Phillips curve. According to the Phillips curve, there is an inverse relationship between inflation and unemployment rate. That is higher the inflation rate, lower the unemployment rate (or higher the employment rate) and lower the inflation rate, higher the unemployment rate (or lower the employment rate). Again there is a strong relationship between inflation rate and interest rate. At the high inflation rate, government always tries to increase the interest rate to reduce the money supply or cash flow in the hand of the common people. But in this high rate of inflation, the employment level is also high, as per the norms of Phillips curve (Krugman 2015). The relationship between inflation and unemployment can be shown by using the Phillips curve diagram, as in follows: –

From the above figure, it can be shown that, in case of short-run Phillips curve, if Inflation rate is I₁, then unemployment rate is U₁. Now, if the inflation rate increases from I₁ to I₂, then the unemployment rate fall  from U₁ to U₂. This decline in unemployment rate indicates the increase in employment rate .Hence, there is a positive relationship between inflation rate and employment. Therefore, to increase the employment rate, existence of inflation in some extent is necessary for any country (Mankiw 2012). That is why the Federal Reserve wants to see more jobs before it raising the interest rate. U.S. has just overcome from the financial crisis and the present rate of inflation of U.S. is -0.2%. This is a very low inflation rate and the Federal Reserve desires high inflation rate than that which can help in increasing the employment rate. At this moment, if Federal Reserve increases the interest rate, then the amount of cash flow in the economy will decline which will lead to a fall in inflation rate farther. And, a fall in inflation rate will result a fall in employment rate, which is not desirable for development of the U.S. economy.

Year	Annual GDP growth rate (%)	Inflation Rate (%)	Unemployment Rate (%)	Interest Rate (%)
2005	3.3	3.5	5	2.9
2006	2.2	2.0	4.5	4.7
2007	2.3	2.5	4.7	5.2
2008	0.8	1.1	6.8	3.1
2009	-3.3	-0.2	9.9	2.4
2010	3.1	1.1	9.8	2.0
2011	1.2	3.4	8.7	1.2
2012	2.7	1.8	7.8	1.4
2013	2.3	1.2	7.0	1.7
2014	2.7	1.3	5.8	1.7
2015	2.9	-0.2	5.5	1.7

Identifying the macroeconomic model

 

Hence, from the above chart and diagram, it can be shown that in last decade i.e. from 2005-2015, there is a fluctuation in economic growth rate. From 2005 to 2009 there is a continuous fall in GDP growth rate from 3.3% to -3.3%.  But from 2010, it started to recover and reached at 3.1%. But after 2010, it again declined at 1.2% at 2011. After 2011, it again started to increase and has finally achieved the growth rate of 2.9% (Tradingeconomics.com 2015).

 Now, concentrating on the data of inflation rate of U.S. over the period 2005-2015, it can be seen that with the fluctuation of annual GDP growth rate, the rate of inflation has always fluctuated over the period. With the decline in GDP growth rate during the period of financial crisis (2005-09), the inflation rate has also declined and in 2009, when the GDP growth rate was negative (-3.3%), the inflation rate faced by the country was also negative (-0.2%). With the increase in GDP growth rate from 2010, the inflation rate also started to increase. But, in the present year, it again fall to the level of -0.2%, though there is a rise in the GDP growth rate (2.9%) compare to the previous year (2.7%).

From the above data and chart, it can also be seen that with the fall in inflation rate, there is a rise in unemployment rate in U.S. economy all over the period of last ten years, which is following the principle of Phillips curve.  But in 2015, when the inflation rate is lowest i.e. -0.2%, the unemployment rate has also declined at 5.5% from 5.8%. This is an exceptional case, when lower inflation leads to lower unemployment rate. This situation has occurred just for the lack of job opportunities (Data.worldbank.org 2015).

During this period, the rate of real interest rate has also fluctuated over the period. From 2005 to 2007, the real interest rate of U.S. economy was increased by Federal Reserve to control the inflation rate.  In 2009, the inflation rate was much lower and as a result, the Federal Reserve started to decline the interest rate to achieve a minimum level of inflation as increase in inflation leads to increase in employment rate (Houston Business Journal 2015). At present, where inflation rate is negative, Federal Reserve has decided not to increase its inflation rate further. That is why the real interest rate in U.S. is remain same at the level  1.7% during the past  three years (i.e. from 2013-15).

The present scenario of U.S. economy in terms of inflation and unemployment rate

Though there was a sign of economic slowdown in 2006, the recessionary phase in U.S. started to begin from the end of 2007 and became clearly noticeable in 2008 (Cushman 2015). This recession caused a massive cut-off in the total employment level of U.S. The main reasons, behind this great recession are:-

In U.S., there was existence of Shadow banking system. This Shadow banking system includes the investment bank and other financial entities which are non-depositary. Though it was not subject to the same regulatory safeguards as the depository system, it had grown to rival the depository system.

Housing bubble was the most important characteristics of U.S. economy.  There was a fall in private residential investment in housing construction nearly four percent, when this housing bubble burst. This led to a decline in GDP rate and consumption level and U.S. government was not willing to compensate the shortfall of private sector (Koutentakis 2014).

In U.S., once the housing prices began falling in 2006, there were a record levels of household debt accumulated in the decades preceding the crisis which resulted a “balance sheet recession”. As a result, the consumers began paying down debt, which reduced their consumption and slowed down the economic growth rate during the period of 2006-2008 (Martin, Sunley and Tyler 2015).

The economic policies taken by the U.S. government towards the housing market was also a cause behind the recession faced by U.S. economy. There was also financial turmoil which led to a rise in money demand and a fall in commodity demand (Gosling and Eisner 2015).

Conclusion and recommendation:-

Hence, from the above discussion it can be said that to increase the employment rate, stabilization policy of Federal Reserve regarding the interest rate is not enough. Inflation may not increase even after taking that stabilization policy as seen in the year 2015. For declining the unemployment rate in U.S. economy, it is very essential for U.S. government to adopt some relevant policies for increasing the job opportunities in U.S. labor market. Seven types of policies may be discussed in this regard, such as, providing compensation to the consumers, providing unemployment insurance to the laborers, simplifying the tax for the small business, proving health-care facilities, implementing the regulatory reform etc. 

Houston Business Journal

https://www.bizjournals.com/houston/news/news-wire/2015/06/17/fed-wants-to-see-more-jobs-before-it-raises.html

Fed wants to see more jobs before it raises interest rates (Video)

Jun 17, 2015, 1:44pm CDT

Kent Hoover

As expected, the Federal Reserve decided against raising its federal funds rate this month from the near-zero levels it’s been since the financial crisis.

In its statement, the Fed said it won’t begin raising interest rates until “it has seen further improvement in the labour market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

The Fed, however, sounded fairly confident in the economy’s progress since a dead-in-the-water first quarter. Since then “economic activity has been expanding moderately,” it noted. More jobs are being added, household spending has grown moderately, and the housing sector has shown some improvement, it noted.

“However, business fixed investment and net exports stayed soft,” the Fed said. “Inflation continued to run below the committee’s longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports.”

Going forward, it expects the economy to grow at a moderate pace, with the labour market continuing to improve.

So now the question is whether the Fed will start to raise interest rates in September, or wait until December.

Fifteen out of 17 Fed members expect it will start to raise interest rates this year; the other two said that should wait until next year.

References

Beckworth, David M. 2012. Boom And Bust Banking. Chicago: Independent Institute.

Cushman, Thomas. 2015. ‘The Moral Economy Of The Great Recession’. Soc 52 (1): 9-18. doi:10.1007/s12115-014-9852-4.

Data.worldbank.org,. 2015. ‘Data | The World Bank’. https://data.worldbank.org/.

Gosling, James J, and Marc Allen Eisner. 2015. Economics, Politics, And American Public Policy. Hoboken: Taylor and Francis.

Houston Business Journal,. 2015. ‘Federal Reserve Keeps Interest Rates Unchanged; Waiting For Additional Jobs, Higher Inflation Before Increasing Federal Funds Rate (Video) – Houston Business Journal’. https://www.bizjournals.com/houston/news/news-wire/2015/06/17/fed-wants-to-see-more-jobs-before-it-raises.html.

Koutentakis, Franciscos. 2014. ‘Gender Unemployment Dynamics: Evidence From Ten Advanced Economies’. LABOUR 29 (1): 15-31. doi:10.1111/labr.12037.

Krugman, Paul. 2015. Macroeconomics. [Place of publication not identified]: Worth Pub.

Mankiw, N. Gregory. 2012. Macroeconomics. New York: Worth.

Martin, R., P. Sunley, and P. Tyler. 2015. ‘Local Growth Evolutions: Recession, Resilience And Recovery’. Cambridge Journal Of Regions, Economy And Society 8 (2): 141-148. doi:10.1093/cjres/rsv012.

Tradingeconomics.com,. 2015. ‘TRADING ECONOMICS | 300.000 INDICATORS FROM 196 COUNTRIES’. https://www.tradingeconomics.com.