Question

In a speech, titled Recent Economic Developments, Monetary Policy Considerations and Longer-Term Prospects in June 2016, Jerome Powell, a member of the Federal Reserve’s Board of Governors, then, stated that the fraction of the U.S. population aged 25 to 54 who were working or actively looking for work “is now below those of most other advanced economies, including the U.K., France and Germany, for example” (para. 7). He also stated, “I am inclined to believe that there are potential workers at the margins of the labor market who will return as the recovery continues” (para. 7). Evaluate Powell’s two statements, and explain how the two statements are related. Why is it important for the Federal Reserve to accurately estimate how many people might still be brought back into the labor market as economic recovery continues? Why might it be difficult for the Federal Reserve to make such estimates? What potential policy errors might the Federal Reserve make if its estimates are inaccurate? Use the AD-AS model/graph to demonstrate your responses.

Answer with graphs, total 250 words

Answer 1

Powell statement includes all workers who are aged between 25 to 54 and hence represent set of active workers. In other statements he assumes cyclical workers who shall return to work as economies improve.

By this he correlates that unemployment has significantly decreased.

It is difficult for Federal reserve to make such estimates as there are various unpaid and voluntary job taken by workers which are unaccounted. Also it doesn't take into account returned workers as well as young interns. It also unaccounts discouraged workers thus rendering monetary policy to inefficiency  

Fed reserve if uses such inaccurate data with irregularities can lead to misestimation of macro economic variables and hence may bring in unexpected rate hikes considering decrease in unemployment . This can lead to decrease in money supply in market and aggregate demand shall fall drastically causing prices to come down. This will negatively affect the real GDP and lead to degrowth.

The policy is called as contractionary monetary policy as shown in below diagram  

Such an effect can lead to misrepresentation of facts and Government to adopt contractionary fiscal policy by increasing taxes or reduced government expenditure as shown above.

Fiscal and monetary policy generally see immediate tools to response to recessions and inflation . Economic stabilization during inflation forms the biggest concern because it drastically affects national GDP, decreasing unemployment, increase in credit supply and aggregate demand, inflationary prices of goods and over appeciation of currency. Thus government often adopt an contractionary fiscal policy stance through implementing of higher taxes and lower public expenditure. However it hasbeen empirically proven that the time taken for decisions making and execution of such policy causes considerable lags which nullifies the positve outcome and effects it should have on economic recovery and hence becomes counterproductive.