Question

Is the Fed's current monetary policy contractionary or inflationary? Does it line up with the SR phillips curve or the LR?

Answer 1

The Federal Reserve has been pursuing contractionary monetary policy since December 2015.

To elaborate, after the financial crisis of 2008-09, the fed cut federal fund rates to near-zero levels (expansionary monetary policy) as unemployment increased, economic growth declined and the rate of inflation also declined.

As the US economy recovered gradually, the federal reserve started pursuing contractionary monetary policy since December 2015. From near-zero levels, the federal fund rate currently stands at 2.5%. The increase in interest rate has been in-sync with declining unemployment, robust GDP growth and relatively higher inflation.

Therefore, the current contractionary monetary policy is in-line with the "Short-Run Phillips Curve."

The short-run Phillips Curve depicts the inverse trade-off between inflation and unemployment. As is the case after 2008-09, inflation declined and unemployment trended higher. However, as unemployment declined ( on economic recovery), inflation trended higher and the federal reserve pursued contractionary monetary policy. This inverse relation is depicted in the given scenario.

Note: The long-run Phillips Curve is a vertical line at the natural rate of unemployment. Therefore, in the long-run, inflation and unemployment are not related.