Question

6.Fed is split over time of rate rise

  

In October​ 2009, the Fed was forecasting that unemployment will average 9.8 percent in 2010 and said the federal funds rate will remain​ "exceptionally low" for​ "an extended​ period." But some officials were beginning to worry about unwinding the​ $2 trillion in special credits that have boosted the monetary base and to wonder if the interest rate might need to start rising soon.

​Source:

The

New York​ Times,

October

​ 9, 2009

Describe the time lags in the operation of monetary policy and explain why they pose a challenge for the Fed in deciding when to start raising the federal funds rate target in a recession.

The time lag between the implementation of monetary policy and the resulting change in the inflation rate is approximately​ ______.

This poses a challenge for the Fed in deciding when to start raising the federal funds rate target in a recession because​ ______.

A.

1​ year; if the Fed raises the federal funds rate too​ soon, it could lengthen the recession

B.

a few​ months; fiscal policy has a shorter lag time and monetary policy and fiscal policy are always coordinated

C.

2​ years; if the Fed raises the federal funds rate too​ soon, it could lengthen the recession

D.

a few​ months; Congress must agree on monetary policy and they are not always in Washington when these decisions must be made

E.

2​ years; fiscal policy has a shorter lag time and monetary policy and fiscal policy are always coordinated

Answer 1

Question 6

Fed conducts monetary policy to stabilize the economy.

Fed targets federal funds rate to influence the money supply in the economy which in result bring changes in the interest rate, aggregate demand, output, and inflation rate.

However, impact of policy action taken by Fed on these elements take different amount of time to show result.

For instance, any change in monetary policy take at least two years to show its impact on the inflation rate.

Such long time lag create dilemma for Fed with respect to change in federal funds rate.

If Fed increases federal funds rate too soon while fighting recession in anticipation that inflation rate is about to rise then this step can lengthen the recession as impact on inflation may not be visible for considerable period of time.

Hnce, the correct answer is the option (c).