US monetary policy and economic effects

U.S. MONETARY POLICY IN THE 1990s

Monetary Policy

Monetary policy refers to actions the Federal Reserve (Fed) takes to influence the amount of money and credit in the U.S. economy. Interest rates and the performance of the economy are affected by what happens to money and credit. The rapid increase in the supply of money and credit over time could result in inflation, a sustained increase in the general level of prices, which translates into a decline in the value or purchasing power of money. The goals of monetary policy are to promote maximum employment, stable prices, and moderate long-term interest rates. Effective monetary policy by the Fed can maintain stable prices thus supporting economic growth and employment ("Monetary Policy Basics, NDI).

Discussion

The low inflation rates of the 1990s were not unique, but were a marked change from the 1970s and 1980s. The 1950s and 1960s were also periods of low inflation, however, according to Gregory Mankiw (2001) the difference was in the 1990s held a much higher degree of inflation stability. A highly volatile inflation rate creates unnecessary risk for both debtors and creditors. Inflation stability coupled with a concurrent stability in both economic growth and unemployment led many to conclude the Fed was doing an amazing job. However, Mankiw asserts the Fed, and Fed Chairman Alan Greenspan, may have also been lucky.

The Fed's job is to respond to shocks in the economy in order to stabilize output, employment and inflation. A demand shock, such as a stock market crash, pushes output, employment, and inflation in the same direction and is relatively easily handled by lowering interest rates to increase the supply of money. Supply shocks, such as a jump in oil prices, are likely to be more complex, fueling inflation and threatening recession, leaving the Fed the task of trading off between inflation stability and employment stability. During the 1990s, unlike previous decades, supply shocks were uncommon.

The growth of productivity and technological advances during the decade was not unusual, however the smooth advance of the throughout the decade was, which might explain low volatility in other macroeconomic variables. Additionally, the stock market yielded high returns and low volatility making it one of the best times ever to invest in Wall Street. The bull market of the period helped to accelerate the productivity rate and drive the business cycle.