¶ … economic and financial crisis (2008-2009), the Federal Reserve took exceptional measures in order to combat the effects of the crisis on the American economy. These measures translated into an expansionary policy that included pumping money in the economy and purchasing assets that were in trouble. Through its expansionary work, the government was able to balance some of the effects of the crisis.
The question that seems to be on everybody's mind (and lips) today is where does it all end? One thing everyone can agree on is that this type of expansionary policy cannot last forever. The United States economy functions as a free market economy where the laws of supply and demand govern the realities of the market. A continuous and permanent intervention of the Federal Reserve is neither possible, nor healthy. What nobody can agree on, however, is when the expansionary approach should stop: now, in the near future, in the medium or even long-term?
The question to this paper can only be answered through an assessment of the state of the economy. This article supports the idea that the economy has not yet entered a phase of sustained recovery and that, as a consequence, the expansionary approach should be continued for a certain amount of time. It argues that, despite some positive signs, many of the figures remain dwindling. Unemployment is still significant and economic growth remains small. This article also proposes that the Federal Reserve put aside, for a while, its continuous focus on inflation, and look into some of the measures that need to be taken in order to combat the growing unemployment.
Expansionary policy is a policy that aims to "expand the money supply," usually done to encourage economic growth (Investopedia, n.a.). From a monetary perspective, this is done when the Federal Reserve increases the money supply available in the economy. From a fiscal perspective, this can be done with decreased tax rates that help boost the economy. In either case, governmental spending is also used to finance project, thus creating jobs. From a monetary perspective, this is also where the multiplier effect is used. When the Federal Reserve increases its monetary base (by printing money), other monetary aggregates, like bank deposits, increased by a lot more. The respective different is the multiplier effect.
What does ending the expansionary policy mean for the Federal Reserve? An exit strategy will include several components. First of all, it would mean divesting some of the investments that the Fed has helped finance in 2009. These are the famous bailouts that the government committed to and that meant that, in a highly unusual fashion, the state purchased parts of private entities. Second of all, it is all about interest rates: raising interest rates would allow the Fed to reduce the money supply, because there will be greater incentives to place money in bank deposits rather than spend them (which would actually encourage consumption and, potentially, inflation). Keeping interest rates low, however, would lower that incentive: people would likely not place money in deposits, but would rather spent or invest in the economy.
Beyond these theoretical considerations, in order to defend this point-of-view, a useful place to start is the Federal Reserve's own position on this topic, as expressed by Janet L. Yellen in a testimony before the Senate Banking Committee. She stated that time for an exit had not come (Mankiw, 2013). In her view, unemployment remained too high and the Fed still needed to help. She turned away from arguments that this could foster inflation, because, in her opinion, inflation was below the 2% benchmark.
Even someone like Mankiw, who opposes this approach, admits that numbers support the story. Unemployment is 3% higher than in 2006, just two years before the crisis. The employment to population ratio is 5% lower (Mankiw, 2013). Unemployment seems to be the core issue in this case and it cannot, as Mankiw does, be attributed to an aging population. Let's look a little closer into this unemployment issue.
What does unemployment basically mean? People who are not working will not be able to earn money. In the end, this in turn leads to a decreased consumption, which means that the products and services that companies are making and launching on the market have no demand. No demand eventually means lower supply and lower economic activity. As it is obvious, this will lead to a continuous economic crisis, with dramatic consequences.
Unemployment can also mean, as Paul Krugman commented, hysteresis (Krugman, 2013). Hysteresis is a phenomenon whereby unemployment becomes structural. Structural unemployment is almost perpetual: the problem becomes so systemic that it is difficult, if not impossible, to combat it, no matter what the policies that the Fed adopts. This is a real and dangerous threat. An unemployment...
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