Fed Meeting August 2008

One of my assignments at the University of Delaware this summer was to read up on the current state of the U.S. economy and make a policy recommendation for the Federal Reserve FOMC meeting of August 5. We will see if I was in the neighborhood of Bernanke, Mishkin, and the gang at the conclusion of today's meeting.

The Federal Open Market Committee (FOMC) finds itself stuck in the crux of its dual mandate of full employment and price stability. The economic times are further complicated by the crisis in the financial industry and volatile oil prices...

Policy Recommendation: The Federal Reserve’s dual mandate of full employment and price stability makes the current situation incredibly difficult. While weak growth numbers and falling consumer confidence is a worry, one of the biggest issues in our current situation is providing liquidity to the financial sector. If banks are unwilling to borrow and lend, money growth and therefore economic growth becomes difficult. Indeed, many of the steps taken by the Federal Reserve in the past months have been to shore up the financial sector and safeguard the larger economy from further damage. This said, I also am very concerned about inflation. The current inflation numbers are higher than we have seen in quite some time and I fear that these effects will spill over into expected inflation. Once rising inflation is built into expectations it is very difficult to tame. On the one hand, it seems that inflation has been confined mainly to food and energy, (confirmed by the much lower core-CPI rate) and the Fed continues to forecast lower inflation rates later this year and next year. Indeed, inflation pressures may be easing a bit evidenced by the recent decline in oil prices. On the other hand, the Fed was very aggressive in cutting rates over the past nine months. The lag time necessary for policy to have its intended effects means that the cuts of this earlier this year won’t be fully felt until late this year and into next year. As these cuts start to have their intended effect, the current inflation problem may well become even more pronounced. Another consideration is the political business cycle. While the incumbent president is not running for re-election, the Fed might appear least biased by not increasing the interest rates until after the election. As I weigh these very heavy issues, I recommend that the Federal Reserve maintain the current 2% Federal Funds Rate with a clear statement expressing inflation concerns and a clear signal that the Fed remains ready to raise rates if necessary. Leaving rates the same will give the financial sector breathing room while they recover from the current situation and it will give the Fed time to see if policy is working and if inflation is in the process of retreating.