Monetary policy is the action taken by a country's Central Bank to manipulate those macroeconomic factors in order to meet the country's economic goals. The Federal Reserve Act of 1913 established the Federal Reserve as the custodian of monetary affairs in the United States. To carry out this mandate, the Federal Reserve effectively assumes the management of three monetary policy instruments. Open-market activities, the rate of discount, and the reserve requirement are the three instruments. The BoG controls the discount rate and reserve conditions, while the Federal Committee on Fair Markets manages open market activities. By applying the devices, the Fed can influence the balances it holds on behalf of depository institutions, the demand for, and supply of money. This control enables the Fed to alter the federal fund's rate. The alteration of the federal fund's rate sets in motion a series of events that in turn influence other economic variables. These include short and long-term rates of interest, the amount of money and credit, foreign exchange rates, and the final effect is a change in the macroeconomic variables such as output, employment, and price level.
The FOMC Structure
FOMC comprises of the members of the Federal Reserve System’s Governing Board who are seven in number, New York's Federal Reserve Bank president; and four Bank presidents out of the other constituent Reserve Banks. The terms of service of these four presidents are on a rotational basis. Every year, the Committee holds eight meetings. During these meetings, the Committee revises and sets the proper levels of monetary policy, evaluate its long-term goals of employment, the stability of prices and examines the financial and economic conditions of the country.
Statement of Goals of Monetary Policy
The FOMC has a commitment to fulfill its mandate of promoting stability in prices, moderate long-term rates of interest, and maximum employment. The Committee also has a duty to explain as clearly as possible its monetary policy decisions. Such clarity enables business owners and household heads to make well-informed decisions which in turn enhances the effectiveness of monetary policy, reduces financial and economic uncertainty and improves accountability and transparency. Long-term interest rates, employment and inflation change in response to fiscal and economic shocks. Monetary policy actions do have a lagged influence on economic activity and price levels. The policy decisions of the Committee usually reflect its medium-term outlook, its long-run goals and its evaluations of the balance of risks. These risks include those that are threats to the financial system that could be an impediment to the targets.
Over the longer monetary policy primarily determines inflation rate. The Committee, therefore, can set a long-term target for inflation as may be deemed appropriate. The Committee has set a long-term rate of inflation at 2%.This percentage is as measured by variations in consumer price index. The rate is the most consistent with the statutory mandate of the Federal Reserve. If inflation persistently runs below or above this objective, then there will be a great concern. A clear communication of this symmetric inflation goal to the public is essential as this keeps the longer-term expectations of inflation stable thus enhancing stability in prices and long-term interest rates. This will improve its ability to promote maximum levels of employment even in the event of economic disruptions.
Non-monetary factors affecting the dynamics and structure of labor markets determine the maximum level of employment. These factors do change from time to time, and they may not be measured directly. That being the case, it becomes inappropriate to specify a goal for employment that is fixed; instead, the Committee makes decisions that are informed by evaluations of the maximum level of employment taking into recognition the fact that these assessments are uncertain hence subject to revision. To make these estimates the Committee takes into consideration a wide range of indicators. Four times a year the Committee participants publish information of their estimates in the Summary of Economic Projections. The Committee seeks to mitigate deviations of employment from the assessed maximum level and the deviations of inflation from its longer-run goal.
The objectives complement each other. However, there are circumstances under which the Committee may judge that these aims are not complementary. Should that happen, then it follows a balanced approach to promote them. In doing so, it takes cognizance of the magnitude of the deviations as well as the potential difference in the period of adjustment of inflation and employment to consistent levels. In its annual organizational meetings every January, the committee reaffirms these principles and also makes appropriate adjustments (www.federalreserve.gov/monetarypolicy).
Recent FOMC Meetings and Press Releases
December 13-14, 2016: The Committee raised the fed funds rate from 0.5 to 0.75 percent. The Fed was satisfied with the prevailing economic growth rate, and it expected inflation to reach its 2 percent target in 2017. However, some Committee members raised concerns over the persistently low interest rates citing that the situation was likely to create a liquidity trap (FOMC Dec 1, 2016, Press Release).
January 31 - February 1, 2017: The FOMC kept the fed funds rate unchanged at 0.75 percent. The move followed information received since the December 2016 meeting that showed continued strengthening of the labor market and the moderate pace of economic activity. Job gains stayed stable, and the unemployment rate stagnated at their low rates. Inflation increased, but it was still below the 2 percent longer-run objective. It was expected that if the position of monetary policy adjusted gradually, economic operations expanded moderately, and conditions in the labor market continued to improve then in the medium term, inflation would rise to 2 percent (FOMC Feb 15, 2017 Press Release).
March 14 – 15, 2017: The Fed funds rate was raised to 1 percent. Members exuded confidence that the economy would strengthen further. The inflation rate was reported to be close enough to the Fed's target of 2 percent. These decisions were informed by information received since the FOMC meeting in February. The indications were that there was continued moderate expansion in economic activity and further strengthening of the labor market. There was a slight change in the unemployment rate in the preceding months, but job gains were still solid. Given the realized and the expected inflation and conditions of the labor market, the Committee raised the federal fund's rate from 0.75 to 1 percent. It was reported that the accommodative stance of monetary policy would ensure a sustained return to 2 percent inflation. The Committee expected that the conditions of the economy would turn out in a way that would guarantee slow rises in the federal fund's rate which at the time remain below its expected long-run levels (FOMC March 15.2017 Press Release).
U.S Economic Outlook 2017 and Beyond
According to forecasts released by the FOMC on March 15, 2017, the U.S. GDP growth rate is estimated to be 2.1 percent in 2017. The rise is expected to remain at that level in 2018 and then fall to 1.9 percent in 2019. The rate of unemployment is estimated to fall to 4.5 percent from 2017 onwards. The inflation rate is estimated to be 1.9 percent in 2017 and 2.0percent from 2018. The interest rate is projected to go up to 1.5 percent in 2017 to 2 percent then to 3 percent in 2018 and 2019 respectively.
In discussing these forecasts participants held the opinion that the appropriate upward path of the federal fund's rate was likely to be gradual over the next few years. This pace is attributed to the currently low short-term neutral real interest rate as well as a gradual return of inflation to the 2 percent objective. Should the economy evolve, it is anticipated that the committee's reinvestment policy may have to change before the end of the year.
Conclusion
The Federal Reserve implements the United States' monetary policy which has a direct effect on the interest rates and also affects wealth, stock prices, as well as rates of exchange. Through these channels, monetary policy influences production, spending, employment, levels of investment, and inflation rate. The FOMC economic projections are subject to uncertainty and risks, thus in charting the appropriate monetary policy for the country, a range of possible outcomes are taken into account, the probability of their occurrence, as well as the costs and benefits their existence may bring to the economy.
Works Cited
BOARD OF GOVERNORS of the FEDERAL RESERVE SYSTEM20th Street and Constitution Avenue N.W., Washington, DC 20551. Web. April 15, 2017.
The balance. Make money personal. Web. April 15, 2017.
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