The Federal Reserve System is the highest financial institution that governs the country’s financial dealings. It is charged with among many other roles regulating money supply plus dealing with the issues of inflation though it can only put measures to combat it but has no capacity to directly influence it in a free market such as the case with the US. In the last five years the Federal Reserve Board has come into the limelight especially due to the prevailing high levels of inflation in the country and the world that have peaked. For instance, inflation in the US is expected to hit over 3.8%. Much of it has been blamed on the increased world energy prices especially petroleum. The effect of the rampant inflation has touched literally on all the sectors of the economy. In this paper, we thus look at the effects of inflation in the last five years and the role of the Federal Reserve Board in combating it.
Impact of inflation in the US economy
Economic reports from the Federal Reserve System have indicated that inflation in the last four quarters have averaged between 3% and 3.5% with the month of May hitting 3.7%. What has inflation got to do with then? In simple terms, it is said to the general increase in price levels. As a result there is decreased real wages among households and all the players in the economy. Inflation triggers off a cyclical pattern that will in the end touch on everyone.
A recent survey by Yale economist Robert Shiller found that many Americans view increments in prices over time as a reflection of fundamental changes in the values of our society, rather than due to market dynamics. In such a case the situation worsens with decreased spending by households rebelling against purported exploitation by firms. Households will be quick to accuse certain firms of increasing the costs of their products instead of blaming the rise on the prevailing economic forces that trigger rise in price of products resulting from rise in cost of production.
Inflation in general leads to decreased economic activities in the long run. This was echoed by Richard Fisher, president of the Federal Reserve Bank of Dallas, who said that he was more worried about the fall in economic activities rather than the persistent rise in the general price level. A fall in economic activity has also led to a rise in unemployment levels which as of May stood at 5%. What now remains to be seen is the board’s competency in combating inflation through some of the policies that it has put in place.
Role of Federal Reserve Board
The Federal Reserve Board is appointed by the president to oversee the running of the Federal Reserve System. It is also responsible for advising the all the 12 regional Federal Reserve Banks, components of the Federal Reserve System on the best financial policies and strategies that will ensure growth and good economic environment void of inflation (Thill, 2006 pg 234). Keeping inflation under control and a sound monetary policy facilitates the ability of households and firms to plan and increases their appetite in making investments either tangible or intangible.
Formulation of relevant monetary policies. The current are inflation rates are alarming and have been largely attributed to the increment in oil prices world wide. Global economic crisis is not a new event to the world. Another case of oil shortage bringing about inflation was witnessed in the early 1970’s popularly known as the oil embargo of the 1970’s. Though the effects of the rise in cost of energy do not have an immediate effect on inflation, the monetary policies put in place to combat such a rise in energy prices determines the prevalence of inflation and its impact in the immediate future. The board has registered considerable success in averting the high oil prices fully spilling into other sectors of the economy.
The Federal Reserve and other central banks through the guidance of the board have learned the lessons of the 1970s. Because monetary policy is time consuming, the short-term inflationary effects of a sharp increase in oil prices cannot be comprehensively be done away with. However, since its formation, the Federal Reserve has been firmly committed to maintaining a low and stable rate of inflation over the longer term. Economists recognize that keeping longer-term inflation expectations well anchored is essential to achieving the goal of low and stable inflation. It is important at this juncture to note that 0% inflation is not recommended as it has its own detrimental effects. Maintaining confidence in the Board’s commitment to price stability remains a top priority as the Central Bank navigates the current complex situation.
As an adviser to the Federal Government, the board has recommended the lowering of lending rates by banks and tax cuts so as to stimulate consumer spending which economists say accounts for 70% of the US economic activity. By stimulating consumer spending which has seen a hike in Consumer Price Index (CPI) from the desired 2.0% to over 2.3%, maintaining the desired level in some way will return the situation to normal. The Board was largely associated with the enactment of the Economic Stimulus Bill of 2008.
The activities and recommendations of the board however, do not go without criticism. After realizing the impact of inflation, critics and analysts are now proposing that the board should now be considering hiking rates as continued lowering of rates adds more money in circulation which in turn further fuels inflation. If economic theory is to hold then we should brace for hiking of interests rates as per the critics suggestion. If the board subscribes to theory, then the analysts are right.
Thill, J. & Bovee, C. (2006). Excellence in Business Communication, New York: Prentice Hall, pp. 234, 267.