Howdy, gang! Now that we’ve discussed fiscal policy, let’s take a look at monetary policy and see if we can notice the differences. Monetary policy is essentially the way in which the government uses the supply of money in order to influence and/or manipulate the country’s economic performance. There are a few things that the government can use (and they’ve done this over and over since the inception of the U.S. Central Banking System and Federal Reserve) in order to achieve their goals, but the biggest tool in their tool belt is the use of interest rates. Simply put, low interest rates tend to increase the amount of money in circulation, which can sometimes help stimulate an economy during a recession.
The opposite side of this is that high interest rates tend to reduce the supply of money and can be used to reduce inflation. Yes, it is safe to assume that the overuse of monetary policy by way of fidgeting with interest rates is a circular argument with circular solutions. In most cases over the past century, the use of low interest rates has increased the rate of inflation, which then calls for an increase in interest rates to combat the self-inflicted wounds of said inflation rates! It’s a vicious cycle that we seem to repeat over and over again, but because we’re talking about policies that involve a lot of time in order to see the effects, most people don’t seem to care that a majority of our national economic disasters have been self-administered. This, by the way, is one of the major reasons that “bubbles” are created in our economy! They’re self-inflicted!
There’s something very interesting about monetary policy, which isn’t true in the case of fiscal policy. While fiscal policy is proposed, agreed to, and then implemented by elected individuals in congress, such is not the case with monetary policy! In fact, the system we’ve allowed to be put in place involves people who are not elected, but appointed. The Federal Reserve is the organization that determines monetary policy and none of the individuals serving in the various positions of that organization have to get permission from our government in order to implement new policies! They essentially do what they think is best, learn from their mistakes, and proceed accordingly without any real personal consequences.
Also, there is supposed to be no political connections between the members of the Federal Reserve (commonly referred to as the Federal Open Market Committee, or FOMC) and members of Congress, the President, lobbyists, or anyone else in highly powerful political offices. They are supposed to be free from the negative consequences of political pressure, quid pro quo, or the temptations of political and personal bribery. I think it’s safe to say that such a notion is optimistic idealism because of the human factor. None of us are perfect and none of us can say that we are 100% above the temptations to do something we don’t agree with when the “incentive” (reward) is greater than the penalty. I wish I could say that the FOMC acts responsibly and completely independent in the best interest of the citizenry, but I can’t. Not 100% of the time, anyways.
When the FOMC sets a new interest rate it is wrong to assume that we will benefit directly by receiving loans at that new interest rate. I mean, think about it! The current Federal Funds Rate (the interest rate set by the FOMC) is set as a range from 0.75% to 1%. Do you really think that you can get a mortgage with an interest rate of 1%? Obviously, the answer is HELL NO! So, what does it mean when the Fed Funds rate is set at near 1%? It means that the U.S. Central Bank will lend money to its federal distributors (the Regional Federal Reserve Banks) at a 1% interest rate. The Regional Banks will then lend to individual financial institutions (local and national banks) at an interest rate of 1% plus another percentage point or two (in order to provide income and stabilization).
Once your local bank has their interest rate benchmark locked in, they will then lend you money at the rate they received plus another percentage point…or two…or seven (depending on risk, aka…your credit history). So, yes…it can be assumed that a lower Fed Funds Rate will mean a lower interest rate for us when we have to take out loans, but it would be erroneous for us to assume that we will secure a loan with an interest rate equivalent to the Federal Funds Rate.
We have been dancing a very historical dance for nearly a decade in regards to the monetary policy of the United States. The Federal Funds Rate was at ZERO percent for nearly the entire time President Obama was in office! It’s now slowly increasing in order to offset the “miniscule” levels of inflation that we’ve been told are developing. I don’t know about you, but if someone tries to tell me that inflation has been miniscule or non-existent for the past decade then I just chuckle. OK…I may not chuckle, but I definitely laugh out loud and then don a face that looks like I just bit into a lemon! The games they (our government officials and the FOMC) play have the potential to be downright dangerous and I don’t find it to be inconsequential, nor do I find it to be amusing in any way. This is serious stuff, but unfortunately…not enough people know about it and the people in charge know this! Hence, the reason for this blog!
Stay tuned for more foundational construction on our platform of understanding regarding macroeconomics! In the meantime, keep working hard and keep setting/reaching your personal goals!
Be good. Do good. Know good.