The monetary policy influences the financial and economic decisions made by people. Be it purchasing a new house or putting savings in bonds, the stock market or banks. This paper discusses the basis of the monetary policies by the Fed in 2001 and 2004. It also discusses the effects of these policies in regards to classical and Keynesian theories and their impact on inflation, GDP and interest rates.
Basis of the monetary policies by the Fed in 2001 and 2004
One eminent custom for crafting fiat policies of the central bank neutral in regard to the financial market is to focus on stability in the amount of nominal expenditure. Stability of the nominal expenditure requires that; money should not be instilled by the Fed via the financial market to counterbalance development in actual output, because of the growing productivity. It should otherwise permit consumer prices of goods to drop when productivity profits decrease the production costs. The 2001 reduction in interest rates by the Fed therefore, was mainly to prevent a prolonged recession and increase the rate of spending in the economy. Expenses brought about by money acquired from remortgaging resulted to over 4% GDP. In 2004, the Fed looked optimistically upon remortgaging as a basis of individual consumption spending (Greenspan, 2007).
Effects of the monetary policies and their impact on inflation, GDP and interest rates
The reduction of short-range interest rates stimulated the increase in the dollar amount of mortgage lending, and contributed to unintended costs for the kind of mortgages written. The Fed’s policies also affect inflation. This comes about when the rate of price increase is very high and the policy encourages collective demands, which may influence markets beyond their abilities over a long period of time. This is because monetary policies that keep their real rates low in the short-run will ultimately lead to elevated nominal interest rates and inflation.
In 2001, the annual rate by the bank reserves was increased by the Fed. Such lags combined with an increase in the banking power amalgamated to a GDP boost in 2004. Increasing the bank reserves offered the liquidity for a tentative boom in organizational leveraging and housing that contributed to the financial ruin (Greenspan, 2007).
Keynesian theory takes on that when government rises its spending or gives credit to different bodies; it increases its sum credit or spending amount. Classical theory on the other hand, takes on that government expenditures and loans occur at the cost of private expenditures and credit. The view of classical theory indicates that when a government attempts to improve credit or expenditures in one economical area, it weakens another. The Keynesian theory stresses the value of interest rates employed as a means to the sum of money or the liquidity of the market. The classical theory does not focus on interest rates but focuses on the total amount of money and the liquidity of the market.
From a classical angle, demand is essentially stated by the Fed policy. Any short-term boost generated by government spending will be compensated by the decrease in credit generated by the rise in borrowing by the government. The consequence of this fiscal exploitation can only be positive when the advantages of the government’s expenditures offset the costs to people who were deprived of credit, because of the government’s borrowing (Warnock & Warnock, 2009).
Warnock, F. & Warnock, V. (2009). International capital flows and US interest rates. Journal of International Money and Finance. Vol. 28:903-919
Greenspan, A. (2007). The Roots of the Mortgage Crisis. Wall Street Journal.