Question

A statement by the Federal Reserve’s Federal Open Market Committee (FOMC) released in 2010 reads:

Information received since the FOMC met in March suggests that economic activity has continued to strengthen and that the labor market is beginning to improve. Growth in household spending has picked up recently. ... Business spending on equipment and software has risen significantly. ... Housing starts have edged up but remain at a depressed level. ... With substantial resource slack ... and longer-term inflation expectations stable, inflation is likely to be subdued for some time. ...The Committee will maintain the target range for the federal funds rate at 0-0.25%.

Explain what kind of monetary policy the Fed is announcing in this statement. Why is this the right policy, according to the statement? What are the intended impacts on the economy (producers, consumers)?

Answer 1

Fed funds rate is the interest rate banks charge each other to lend Federal Reserve funds overnight. Fed is announcing that expansionary monetary policy will stay for some more time .

They are keeping Federal funds rate at very low levels making sure that banks are left with enough liquidity. It is generally done during recessionary cycles. Federal funds rate also affects the prime rate. If inflation goes up then Committee may decide to take these rates up. This move of keeping Fed funds rate at low levels makes money supply to increase and helps to decrease interest rates.

Decreased interest rates encourage investors and people to borrow more and spend more and hence aggregate demand increases generating more jobs in an economy. Both producers and consumer are better off if they are investing but worse off if they are saving money in banks.