Question

In Dec, 2018 the fed funds rate is 2.25-2.5% which is the rate that banks charge each other to borrow reserves overnight. The fed controls the supply of bank reserves by buying or selling Treasury Securities. (Buying treasuries raises the supply of bank reserves and therefore lowers the fed funds rate) It is also gradually undoing quantitative easing (QE) which means shrinking its balance sheet which has assets of 4Trillion! The fed had expanded its balance sheet by creating money to buy long term bonds since the fed funds rate had fallen to 0% and the fed wanted more stimulus following the Great Recession of 2008-2009. In addition fiscal policy was stimulated by the Trump Tax Cuts and a big rise in government spending which could threaten inflation by stimulating economy. The fed has its hands full as inflation rises to its target of 2%! The fed follows the consumption price deflator which is still below 2%(But the CPI is rising at an annual rate of 2.2%) The fed is expected to keep interest rates steady and undo QE very very gradually. Do you think the fed policy is too tight, too loose or about right. More importantly Why? Please include a detailed explanation that backs up your answer. Do you think the fed will raise interest more in 2019? What is the neutral rate? Why is that important? Do you think the fed should use financial market or economic indicators for policy. Why?

Answer 1

Fed policy is perfectly right in increasing interest rates gradually via quantitative easing method as the US Economy has seen inflation in CPI terms around 2.2% and employment is seen reaching full employment where only 4,00,000 workers have been unemployed as of Dec 2018 on approximate basis. Also unemployed workers have been in lesser number than historical trends which tends to create higher purchasing power and hence raises prices gradually. Also if goods coupled by Trump Tax cuts as part of expansionary fiscal policy which can lead to excessive inflation to 3% and abive.

Rhus, US Fed Bank tries to balance the economy into robustness by raising interest rates such that inflation and unemployment in control and simultaneously economic real GDP rises at steady state with adoption of expansionary fiscal policy by Donald Trump government  

Looking forward US fed looks to raise interest rates by another 75 to 100 basis point at maximum in 2019-2020. The neutral rate comes around 2-2.5%. Fed should take aid of financial indicators perhaps these indicators are highly ambigous and lack concrete methodical or empirical approach and has serious flaws.

Hence FEd must navigate on financial indicators to some extent but also look to revise model create for determining financial indicators and economic performance with various secondary sources.