Free «John Taylor: Fed Policy is a Drag on the Economy» Essay

John Taylor: Fed Policy is a Drag on the Economy

The Federal Reserve has put in place efforts to make the economy recover from the situation it underwent in 2008. John Taylor argues that the measures were expected to resuscitate the economy and increase its growth by 4%. However, this did not occur as in 2012, it was only at 2%. The Fed had acquired mortgage-backed and the U.S. Treasury bills. Another mechanism used was broadening the minimum federal funds rate. Because these efforts did not produce the desired results, the Fed came up with a strategy to make another purchase large scale. The federal funds rate was to remain constant for several years. The policy put in place by the Fed in 2008 is seen as the one that has slowed down the complete recovery of the economy. This time they are doing things a bit different. When the economy looks up, the Fed would sell their assets to prevent inflation.

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Taylor observes that the sale of the assets needs proper regulation, because a fast sale will result in a dive in bond prices and an increase in interest rates. If the sales are slow, the bank reserves that financed these assets will pour into the economy and cause inflation. The zero interest-rate policy in place will attract risk-averse investors such as retirees and pension funds. These low rates increase the spending of Congress and the President, which in turn increases deficit and debt. Many people have viewed the Feds policies as a wrong move and have consequently lost confidence in the banks. For the past years since 2008, the Fed has caused swings in money supply, which has led to macroeconomic instability. The move by the Fed is emulated by other central banks to avert their monies from depreciating to the dollar. As a result, 2010 and 2011 saw the money busts and booms.

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Taylor affirms that these busts and booms in money supply are seen as having a great disadvantage, but Federal Open Market Committee says it has a greater advantage. They explain the benefit using a microeconomic view. They say that the low borrowing rates and asset acquisition will result in lower unemployment and increase in economic growth. Many people refute this move by the Fed. They say that the monetary policy of low interest rates and an increase in assets purchase will result in a decrease in demand and an increase in unemployment. This is due to the price system that will adjust because of the incentive created by the low interest rates. The policy of making the interest rates low for several years in the future is seen by many as an incentive to revise investment decisions. Many will borrow more and invest most of their money in long-term bonds instead of short-term bonds. This will see a slow growth as was experienced in 2012.

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Taylor verifies the phenomenon as the forward guidance policy that keeps the interest rates low. The Fed will impose a ceiling on the short-term and long-term borrowing rates. They seek to maintain this ceiling at the equilibrium between lenders and borrowers. This is because borrowers love the low interest rates while the lenders are reluctant to lend at such low rates. This reduces the credit to borrowers that lessens aggregate demand for credit by the borrowers. This, in turn, will increase unemployment. This is the unexplained consequence of this policy by the Fed. Any economist can explain this as a vicious cycle. The best solution needs minimum interventions in the market by the Fed. This is the only solution to the economy that will see it recover fully and within a shorter time.

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