Question

In his New York Times column of May 27, 2005, economist Paul Krugman stated: “After all, the Fed’s ability to manage the economy mainly comes from the ability to create booms and busts in the housing market.” What do you think he means by that statement? Is it an accurate characterization of the Federal Reserve’s influence over the real economy?

Answer 1

Paul Krugmans meaning by statement is that Federal reserve uses interest rate cut to boost housing prices and create demand however it also creates additional employment and consumption which causes boom. At same time to counter this boom and inflation the Fed may raise interest rates to curb this excess inflation which causes bust in market.

However this is not accurate characteristics of Federal Reserve as the central bank adopts mix of policies to counteract different situations like supply shocks and demand shocks and stagflation.

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