By controlling the money supply and setting key interest rates, the Federal Reserve has a huge impact on the economy. It probably has more influence on the economy than the President, especially one that hasn’t been lowering or raising taxes, which also have huge impacts on the economy. (In effect its actions, though not all powerful, have a huge impact on both job creation/destruction and inflation).
Higher interest rates reduce economic incentive to borrow money for houses, cars, factories, stores, etc.. This depression of demand for products and services means we need less people employed to provide these goods and services. Keeping people employed who aren’t needed leads to lower profits and possibly bankruptcy, so layoffs grow and new hires shrink. This accelerates the lack of demand for products and services so that the providers/employers of them have little or no power to raise prices. This dampens price inflation, a necessary step to avoid a spiral of high inflation that can hurt the economy more than it helps. High inflation eventually puts prices of goods and services out of reach of more people, dampening demand and causing unemployment to rise and real wealth to fall.
When the economy is ‘too strong’ the Fed will attempt to raise interest rates to reduce the threat of inflation (note – also read my thoughts on the business cycle to understand the problem with an economy that has become too strong). Conversely, when the economy is too weak, the Fed will attempt to lower interest rates/increase money supply to stimulate the economy to grow. However, the impact of interest rates and money supply take six to twelve months and longer to show their full impact. There are other decisions besides interest rates to consider when businesses try to increase investment or people to buy houses, cars, etc.. Also, many loans already exist and may be immune to incentive to refinance at changed interest rates.
The delay between Fed action and its impact on the economy makes things very tricky for the Fed. It needs to look at current economic conditions which may not be where they want it to be yet and judge whether past Fed actions will get it there without further interference or whether additional steps need to be taken. It is easy to over shoot in either direction. The Fed has been exhibiting a bias to fight inflation above its other goal of high employment. This has led to recessions and forced the Fed to reverse course. Unfortunately, a reversal takes a year or more to get to where it’s needed.
It can be argued that the Fed has not paid sufficient attention to sustained growth in job productivity (i.e. if productivity is up say 4%, a 4% rise in wages is neutral, not inflationary) plus the favorable impact of reduced trade barriers (that force most businesses to become more competitive in price). In other words, the inflation bias has been too strong and the fight for full employment too weak.
Strategically, whenever the Fed targets something as out of whack (e.g. the stock market or housing as it has recently), the tools at its disposal (interest rates/money supply) are too wide impacting to target the ‘bubble’ it seeks to eliminate. It impacts the whole economy and is therefore too powerful a weapon to utilize to control only a segment of the economy. The damage caused is far reaching and can sometimes take years to undo.
Getting it Right - Welcome
The goal of this blog is to publish my thoughts on a variety of economic and political topics in the hopes that people who find them educational or beneficial will utilize them and/or forward to others who might find them interesting and/or worthwhile to promote to others, possibly including politicians who can push some of these ideas to fruition. The topics in my blog are meant to be of value on a long term basis, not a daily diary or political issue of the day log. If the information posted is useful to you, by all means utilize it and/or forward it as you see fit. If not useful, then merely ignore it. There are no universally agreed upon truisms and too little tolerance between some of those with opposing viewpoints to successfully convince the people with hardened opinions to move away from them. I am an analytical type person who will try to be as factual as I am able.
I disdain the current popularity of name calling and condemnation of viewpoints with no factual alternatives or logical solutions given that I see so often. If you don't have a solution based on fact and logic, then opt out of the discussion because you have nothing to contribute. My background is a degree in Economics from the University of Michigan and 39 years working in middle management jobs for a major retailer. My opinions are forged on the personal experence of life, family, friends, and work as well as triumphs and mistakes that I have made and hopefully learned from. My hope is that this blog helps you.
My first topic will be about personal finance. I chose that one first because most of us work long and hard just to survive but not all of us realize our dreams of becoming financially independent from the labors of our work. Much of our political votes/thinking also focus on the economy and in particular how well we are personally doing financially.
It is relatively simple, without sacrificing the enjoyment of living for 'today' and even at moderate incomes, to retire as a millionaire or multi-millionaire, if you focus on that goal consistently from a young age. It is also simple to ensure that your child or grandchild retires rich. It merely requires a one time gift of just $2,000 invested wisely and the passage of time. Please read my first post on this blog to learn more.
An index/schedule of past and future posts and their dates will always be updated so that it becomes the first post that you see below. If the date of a post that you wish to read is preceded by the word "Posted", then find it below or click on the title in the Blog archive to review.
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