Review the Case for Analysis: The Chairman's Quandary on page 361 in the textbook, Economics for Managers Summarize the recent policy of the Federal Reserve concerning the level of interest rates and the reasons for this policy.
Do you agree with this policy? Why or why not?
How does this policy affect the supply of and demand for products and services?
What problems can arise when interest rates are kept very low for an extended period of time? Please include historical examples (including at least one biblical example) of the impact of low interest rates and their effect on the economy.
The Chairman’s Quandary In the spring and summer of 2012, the Federal Reserve appeared to be moving closer to taking additional action to use monetary policy to stimulate the economy. At the meeting of the Federal Open Market Committee (FOMC) in April, Federal Reserve officials reaffirmed their plans to keep short-term interest rates near zero until 2014. However, some officials predicted that economic growth might increase more than expected, war- ranting an increase in interest rates by the end of 2014. Federal Reserve Chairman Ben Bernanke declared that it was “a little premature to declare victory.” He indicated support for a policy of keeping interest rates low and even launching new programs to stimulate economic growth. Although the unemployment rate dropped to 8.2 percent in March 2012 from 9.1 percent in August 2011, momentum in the labor market was still uncertain and inflation had picked up slightly.1 At its June 2012 meeting, the FOMC announced that it would extend a program known as “Operation Twist” through the end of 2012. With this program, the Federal Reserve sold short-term securities and used the revenues to buy longer- term securities to drive down long-term interest rates to stimulate business and household borrowing. Chairman Bernanke also announced that officials were ready to take additional steps to bring down unemployment if the economy did not recover on its own. This policy stance appeared to be a change from April, when Federal Reserve officials seemed to be more comfortable with the economy’s progress. Under Operation Twist, the Federal Reserve would buy an additional $267 billion in long-term Treasury bonds and notes in exchange for an equivalent amount of short-term securities, expanding the total amount of the program to $667 billion. These policy changes were added to the strategy of holding short-term interest rates to near zero, which had been in effect since late 2008, assuring the financial community that these rates would not increase until late 2014, and purchasing more than $2.5 trillion worth of Treasury and mortgage securities.2 Over the course of the summer the Federal Reserve moved closer to taking further action.3 In speeches and testimony, official made it clear that they were not satisfied with the cur- rent state of the economy. Chairman Bernanke noted that the economy appeared to be “stuck in the mud.” Even members of the FOMC, who traditionally worried more about inflation and opposed more action to stimulate the economy, appeared to have shifted their stance. Yet many observers of the Fed still questioned what it would take for the Federal Reserve to act and what would be the impact of these actions. In a press release following the July 31/August 1, 2012 meeting of the FOMC, officials again reaffirmed that they would keep short-term interest rates low through late 2014 and that they would “closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery.”4 Observers noted that Chairman Bernanke was building a case to stimulate the economy and arguing that the Federal Reserve could achieve its goals without causing other problems. A former Federal Reserve vice-chairman said that the phrase “closely monitor” had been used to signal “a readiness to action that was more than the usual readiness to action.”5 Even so, critics still argued that Federal Reserve actions could do little to help the economy, might generate inflation, and would punish savers who were receiving little return on their bond investments.