The vacant posts in the Fed Board of Governors require personnel with adequate skills in regulating money supply and demand. Erudite and experienced individuals are needed to efficiently execute the myriad obligations that sitting on the board has. This essay will provide several pointers that will be paramount in selecting the right person for the said role. The first section will seek to identify whether the candidate is an inflation hawk or an inflation dove, several questions will be posed to the potential candidate to make this revelation. The second part will focus on interest rates and the effects that interest rates have on inflation and unemployment. The third section will examine how economic growth is impacted by inflation and unemployment. Overall, the essay will provide suitable criteria for selecting the right candidate, given the importance of the role played by the board within the economy.
Inflation, Hawk, or Dove
The Fed has two primary mandates commonly known as the dual mandate. The mandates are ensuring that there is price stability and ensuring there is maximum sustainable employment[1]. The body may implement either dove or hawk strategies in their operations. A dove focuses most of the resources and monetary tools on increasing employment at the expense of inflation. Concurrently, a hawk invests in measures to lower inflation as opposed to favoring increased employment opportunities[2]. Janet Yellen was a hawk during the economic boom experienced in 1990. However, she was a dove after her nominated as chairperson of the Fed. You should consider asking the nominees the following questions to assess whether they are hawkish or dovish.
1. Do you value low unemployment or reduced inflation?
2. In reference to the existing economy, which policies would you apply to favor the growth of the economy?
3. When faced with increased consumption, would you tax the consumers or the sellers?
Interest Rates
The interest rate influences the borrowing pattern of investors, during a high-interest rate regime, there is reduced taking up of commercial loans. If the Fed raises the Federal Funds rate, which is the rate at which they advance loans to commercial banks, the banks will in turn charge high rates on loans that they advance to investors to cover the increase in the Federal Funds rate[3]. The rise in interest rates will reduce the money supply in the economy. With the cost of capital being high due to increased interest rates, investors will avoid taking up loans. Without capital, they will not implement income-generating projects, and the output of their businesses will stagnate. With low incomes, the gross domestic product will also reduce leading to low economic growth.
On the other hand, when the Fed lowers its Federal Funds rate, commercial banks lower their lending rates because it is the basis upon which they price their loans. Investors and households take up loans due to the reduced rates increasing the money supply. The borrowed sums are invested in development projects and businesses. The corporations record higher revenues and also hire additional people lowering unemployment. The result is that there is higher economic output[4]. Overall there is increased the money supply, and this increases inflation. However, unemployment reduces.
Counterfactual is essential in reviewing the effectiveness of specific Fed policies. A notable example is what could have happened hadn’t the Fed reduced interest rates after the 2008 financial crisis. Hadn’t the quantitative easing not been implemented, the economy would have continued to stall because money could not have been funneled into the economy and purchases could have remained at a standstill.
However, the case was different in 2015. The fed rate increased decreased from 0.13 % to 0.08 %. However, unemployment rose from 5.4% to 5.5 %. While posing the questions, you should ensure the nominees can explain the relationship between inflation and interest rate.
Unemployment and Inflation
Being in the committee, you will have to realize the relationship between inflation and unemployment. The Phillips curve is an essential tool for displaying this relationship. The Phillips curve shows the inverse relationship between inflation and unemployment. When the money supply is increased through lowering interest rates, employment is increased due to the stimulus in the economy. Due to the increase in the money that is in circulation within the economy, a situation known as demand-pull inflation arises[5]. The increased demand raises the number of jobs which lowers unemployment. However, there was a puzzle in the years 2012 to 2016 where falling unemployment didn’t trigger rising inflation. Unemployment during this period resulted from long-term factors which affected almost all economic units[6]. The wage rigidity was a factor that inhibited the reduction in inflation. Wage rigidity is a phenomenon where companies are not able to reduce employee wages. The phenomenon led to the puzzle because qualitative aspects in the labor market caused the inflation. Also, it is crucial to note that low labor mobility slowed down the changes in the labor market. The aging workforce also contributed to this puzzle since the employees could not adjust their wages; yet, their retirement was near[7]. Therefore, the remaining workers continued earning low wages which increased inflation rates. Consequently, you should ask the nominees the following questions;
1. What were the factors leading the puzzle of the years 2012-2016?
2. What were the appropriate actions that the government could have taken to prevent the occurrence of the dilemma?
Conclusion
You will need to consider the sensitivity of the roles the nominees will assume. Therefore, you should lay emphasis on their competency when it comes to implementation of Open Market Operations. You should also ascertain their ability to confine to their actions to ensure the betterment of the welfare of citizens. Therefore, their response on their hawkish or dovelike personality should be well-thought out. You should also examine their understanding of the influence of the interest rate on the economy. There is a need for them to apply the relationship between interest rate, inflation, and employment in their responses.
Works Cited
Baum, Caroline. The Fed's Love-Hate Relationship with the Phillips Curve, 3 November 2015, economics21.org/html/feds-love-hate-relationship-Phillips-curve-1505.html. Accessed 29 November 2018
Coibion, Olivier., Gorodnichenko, Yuriy., " Koustas, Dmitri. Amerisclerosis? The Puzzle of Rising U.S. Unemployment Persistence, University of California, 2013.
Federal Reserve Bank of Chicago. The Federal Reserve's Dual Mandate, 2018, www.chicagofed.org/research/dual-mandate/dual-mandate. Accessed 29 November 2018
Federal Reserve Bank. Federal Funds Rate - 62 Year Historical Chart, n.d, https://www.macrotrends.net/2015/fed-funds-rate-historical-chart. Accessed 29 November 2018
IG Analyst. What’s the relationship between inflation and interest rates? 2018,www.ig.com/uk/news-and-trade-ideas/forex-news/what_s-the-relationship-between-inflation-and-interest-rates-180416. Accessed 29 November 2018
Pettinger, Tejvan. Phillips Curve. Economics Help, www.chicagofed.org/research/dual-mandate/dual-mandate. Accessed 29 November 2018
Schneider, Howard. " Dunsmuir, Lindsay. "Hawk or dove? Fed's Powell showed markets both sides in debut.” The Reuters, 2018, np.
[1]
Federal Reserve Bank of Chicago. The Federal Reserve's Dual Mandate, 2018
[2]
Schneider, Howard. " Dunsmuir, Lindsay. "Hawk or dove? Fed's Powell showed markets both sides in debut.” The Reuters, p.1.
[3]
IG Analyst. What’s the relationship between inflation and interest rates? 2018, p.8.
[4]
Idem, p.6.
[5]
Caroline Baum. The Fed's Love-Hate Relationship with the Phillips Curve, p. 3.
[6]
Olivier Coibion., Yuriy Gorodnichenko, " Dmitri Koustas. Amerisclerosis? The Puzzle of Rising U.S. Unemployment Persistence, University of California, 2013
[7]
Olivier Coibion., Yuriy Gorodnichenko, " Dmitri Koustas. Amerisclerosis? The Puzzle of Rising U.S. Unemployment Persistence, University of California, 2013, p.197.
