Taking a Look at Forward Guidance

The Federal Reserve has the dual job of ensuring price stability and maximum employment, which are contradictory objectives. The Feds try to achieve the goals through monetary policy which determines the demand and supply of money by controlling interest rates. The Fed’s goal is to achieve a natural rate of unemployment of more or less 5%. When the actual unemployment figures are below the natural rate of unemployment, inflation increases and there is a high demand of goods and services propelling the economy with the ensuing labor demands and the pressure it places on wages, which in turn produces inflation. When the Fed is faced with this scenario, it must increase the rates to slow the growth and achieve price stability (contractionary cycle).

Due to the 2008 financial crisis, the Bank of England employed quantitative easing (an unconventional monetary policy used to stimulate the economy) by cutting interest rates down to 0.5 % and has been keeping it until now. The Bank made the decision to keep QE and the interest rate unchanged in March. Spare capacity (the ability of a firm to produce more of a product than is now being produced) is used by the BoE to justify its use of forward guidance policy (a communicative tool for monetary policy). Low interest rates improved the economy by increasing consumption and investment, which are the components of AD. The AD curve shows the total spending on goods and services in a period of time at a given price level. In constructing on AD

In 2007, the financial crisis began. It was the most intense period of global financial strains since the Great Depression. It had led to a prolonged global economic downturn. The Federal Reserve took exceptional actions in response to the financial crisis to help stabilize the United

The discussion of whether the Federal Reserve should raise the federal funds rate is a highly contentious one. Members of the Federal Reserve (“Fed”) and academic economists disagree about what constitutes appropriate future macroeconomic policy for the Unites States. In the past, the Fed had been able to raise rates when the unemployment rate was under 5% and inflation was at a target of 2%. Enigmatically, since the Great Recession and despite a strengthening economy, year-over-year total inflation since 2008 has averaged only 1.4%—as measured by the Personal Consumption Expenditures Price Index (“PCE”). Today, PCE inflation is at 1-1.5% and has continuously undershot the Fed’s inflation target of 2% three years in a row. (Evan 2015) In the six years since the bottom of the Great Recession the U.S. economy has made great strides in lowering the published unemployment rate from about 10% back down to about 5.5%. In light of this data, certain individuals believe that the Federal Reserve should move to increase the federal funds rate in 2015 because unemployment is near 5% and inflation should bounce back on its own (Derby 2015). However, this recommendation is misguided.

It is clear that the economic policy in general and the monetary policy in particular should be concerned with the overall economic well-being. In this paper we propose to discuss this core topic. We will provide an overall picture of the functioning mechanism. In this regard, the discussion will develop around the governmental policies and of FED, and their scope on the free market. The argumentation will refer to the notion of common good and will try to establish if the measures applied by FED have fulfilled their intended purpose given the recent international financial crises of 2007.

To begin, the article explains the Federal Reserve’s plan to take a careful approach to enacting contractionary monetary policies, policies used to decrease money supply, in the future. Last December the Federal Reserve raised the interest rates after they had been near zero for years to ensure inflation was kept in check and to promote economic growth. It appeared the economy would be in for another increase in the interest rates sometime this year, but the Feds have rethought that strategy. If the Federal Reserve were to continue to raise interest rates it would have short-run and long-run effects on the Money Market, Goods and Services Market, Planned Investment, Phillip Curve, and Aggregated Supply and Demand. These effects are aspects that have to be considered because they express and explain the effects the increase in interest rates has on the economy and explain if the Federal Reserve is enacting the correct policy to achieve their goal.

Congress has handed over the responsibility for monetary to the Federal Reserve, also known as the Fed, but retains oversight responsibilities in order to ensure that the Federal Reserve adheres to the statutory mandate of stable prices, moderate long-term rates of interest, as well as, maximum employment (Labonte, 2014). The responsibilities of the Fed as the country’s central bank are classified into four: monetary policy, supervision of particular types of banks and financial institutions for soundness and safety, provision of emergency liquidity through the function of the lender of last resort, and the provision of services of the payment system to financial institutions, as well as, the government (Labonte, 2014). The monetary role of the Federal Reserve necessitates aggregate demand management. The Federal Reserve defines monetary policy as the measures it undertakes in order to influence the cost and availability of credit and money to enhance the objectives mandated by Congress, which is maximum sustainable employment and a stable price level (Appelbaum, 2014). Since the expectations of businesses as capital goods purchasers and households as consumers exert an essential influence on the main section of spending in America, and the expectations are influenced in essential ways by the Federal Reserve’s actions, a wider definition would involve the policies, directives, forecasts of the economy, statements, and other actions by the Federal Reserve, particularly those

It widely recognized that the monetary policy within a country should be primarily concerned with the pursuit of price stability. However, it is still not clear how this objective can be achieved most effectively. This debate remains unsettled, but an increasing number of countries have adopted inflation targeting as their monetary policy framework. (Dr E J van der Merwe, 2002) This topic of Inflation targeting is a subject which immediately conjures different perceptions from different people. Many feel that low inflation should be a main aim of monetary policy, while others (such as trade union activists) believe that a higher growth rate to stimulate jobs should be the main concern.

Inflation; ‘a situation in which prices rise in order to keep up with increased production costs… result[ing] [in] the purchasing power of money fall[ing]’ (Collin:101) is quickly becoming a problem for the government of the United Kingdom in these post-recession years. The economic recovery, essential to the wellbeing of the British economy, may be in jeopardy as inflation continues to rise, reducing the purchasing power of the public. This, in turn, reduces demand for goods and services, and could potentially plummet the UK back into recession. This essay discusses the causes of inflation, policy options available to the UK government and the Bank of England (the central bank of the UK responsible for monetary policy), and the effects

Inflation is a possible cause of higher unemployment in the medium term if one country experiences a much higher rate of inflation than another, leading to a loss of international competitiveness and a subsequent worsening of their trade performance. If inflation in the UK is persistently above our major trading partners, British exporters may struggle to maintain their share in overseas markets and import penetration into the UK domestic market will grow. Both trends could lead to a worsening balance of payments. The UK government believes that monetary stability (i.e. low inflation) is a precondition for sustained economic expansion.  As the chart below demonstrates, the UK has made progress in reducing the volatility of its inflation rate in the last decade. The era of high and volatile inflation may have come to an end.

In my opinion, how effective low interests rates are to encourage consumers to borrow and spend depends on the elasticity of the demand for loans. If the demand for loans is inelastic, a sharp reduction in interest rates will only increase the loans by a small amount. Please refer to Appendix G. In this case, lowering the interest rates to 0.5% is not enough to stimulate demand. As a result, quantitative easing, another monetary policy is being utilized, as bank rates could not go any lower. Although there are other underlying factors that contribute to the high unemployment rate in the UK, it is shown that reducing bank rates is not the key to solving this problem.

The impact of the change interest rates and inflation has a persistent impact on the well being of any given society. For this purpose it is the understanding that each individual in society should have an understanding of what such changes bring fourth for the man on the street. In this introduction, we are going to introduce certain key points to remember when dealing with interest rate- and inflation changes.

In September 2008, thousands of financial sectors all over the world went bankrupt like dominoes after the failure of Lehman Brothers Bank, which is also known as the Financial Crisis of 2008, caused the severe recession of the economies around the world. In order to help the country out of crisis, the central banks in different countries had to take measures to stimulate the growth of economy. The goal of this essay is to introduce the measures that Bank of England have taken in 2008 of financial crisis and will discuss the macroeconomics consequences and effects. Three measures taken by Bank of England will be presented in first section and how macroeconomics outcomes influenced by policies and objectives will be discussed in the second section.

Forward Guidance is an unconventional monetary policy used by the central bank to provide path for future interest rates to individuals and businesses. Recently, the Bank of England has adopted this policy. In this essay, we will explain the rationale behind the use of this policy with the help of IS-LM model along with AD-AS model. The IS-LM model explains the relationship between interest and income level and changes in equilibrium level through the use of monetary and fiscal policy. Therefore, will be adequate in explaining the logic for applying this policy. Whereas, the AD-AS model may help in analysing the inflation condition of this policy.

Monetary policy involves manipulating the interest rate charged by the central bank for lending money to the banking system in an economy, which influences greatly a vast number of macroeconomic variables. In the UK, the government set the policy targets, but the Bank of England and the Monetary Policy Committee (MPC) are given authority and freedom to set interest rates, which is formally once every month. Contractionary monetary policy may be used to reduce price inflation by increasing the interest rate. Because banks have to pay more to borrow from the central bank they will increase the interest rates they charge their own customers for loans to recover the increased cost. Banks will also raise interest rates to encourage people to save more in bank deposit accounts so they can reduce their own borrowing from the central bank. As interest rates rise, consumers may save more and borrow less to spend on goods and services. Firms may also reduce the amount of money they borrow to invest in new equipment. A