Question

O Fed is split over time of rate rise In October 2009, the Fed was forecasting that unemployment will average 9.8 percent in 2010 and said the federal funds rate will remain "exceptionally low" for "an extended period." But some officials were beginning to worry about unwinding the $2 trillion in special credits that have boosted the monetary base and to wonder if the interest rate might need to start rising soon. Source: The New York Times, October 9, 2009 Describe the time lags in the operation of monetary policy and explain why they pose a challenge for the Fed in deciding when to start raising the federal funds rate target in a recession. The time lag between the implementation of monetary policy and the resulting change in the inflation rate is approximately This poses a challenge for the Fed in deciding when to start raising the federal funds rate target in a recession because O A. 2 years; fiscal policy has a shorter lag time and monetary policy and fiscal policy are always coordinated O B. a few months; fiscal policy has a shorter lag time and monetary policy and fiscal policy are always coordinated C. 1 year, if the Fed raises the federal funds rate too soon, it could lengthen the recession OD. a few months, Congress must agree on monetary policy and they are not always in Washington when these decisions must be made O E. 2 years; if the Fed raises the federal funds rate too soon, it could lengthen the recession

Answer 1

Option E

Time lags can make policy decisions more difficult. It is estimated interest rate changes take up to 18 months to have the full effect. This means monetary policy needs to try and predict the state of the economy for up to 18 months ahead, but this can be difficult in practise. By raising of Federal Fund Rate, the interests rates will become high. As a result borrowing will become expensive. Investments by households and business organisations will become costlier. As a result aggregate demand and spending will reduce. This will further lengthen the recession.