Economics / Unit 10: The Federal Reserve and Monetary Policy
10.6 Challenges and Debates in Monetary Policy
Notes
- Time lags: changes in interest rates can take months or more to affect output and prices, so the Fed must act on forecasts.
- Conflicting goals: fighting inflation can raise unemployment for a time. Stagflation (high inflation and high unemployment, as in the 1970s) is especially hard, because easing worsens inflation and tightening worsens unemployment.
- Since 2012, the Fed has stated a goal of $2\%$ inflation over the longer run.
- Monetarists, such as Milton Friedman, argued the Fed should grow the money supply at a steady rate. Others favor the Fed using judgment as conditions change. Some economists favor clear rules; others prefer flexibility.
- Debates also concern Fed independence (shielding policy from politics versus democratic accountability) and the risks of keeping rates very low for long periods.
| Fiscal policy | Monetary policy | |
|---|---|---|
| Who | Congress and the President | the Federal Reserve |
| Tools | government spending and taxes | interest rates, open market operations, reserves |
| Speed of decision | often slow (legislation) | faster (FOMC meetings) |
Practice
Why is stagflation especially difficult for the Fed?
The two parts of the dual mandate pull in opposite directions.
Which pair is correctly matched?
Open market operations are a monetary policy tool used by the Fed.
Milton Friedman and other monetarists argued that the Fed should:
Monetarists believed steady money growth would keep prices stable.
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