Inflation and Interest Rates
Realistically, the Federal Reserve has two choices for monetary policy in expansionary or contractionary, but it also has the option to keep inflation and interest rates at their current levels as a more intermediate stance. Each choice would garner support from right or left and would have a unique effect on the American public and the general economy, pushing America towards either socialism or capitalism. This decision depends largely on the incumbent president as well, so we will also take both a time and a party-based approach to analyzing the historical success of various policies.
Most recently, in response the 2008 recession, America has seen a nearly decade-long expansionary push to reverse the economic effects of the burst of the housing bubble. While conservatives typically support expansionary policy, democratic president Barack Obama and Federal Reserve chairman Ben Bernanke had little choice but to try to propagate economic growth through any measures possible. The effectively zero interest rate, yielding minimal total inflation, indicate the government’s attempt to force money back into the market to begin rebuilding the economy.
President Trump alongside Fed chairman Jerome Powell have effected small interest rate increases, but the 2.19% effective federal funds rate and 1.90% effective inflation rate still allow consumers to spend without regard to a significant opportunity cost of saving. Since the effects of the recession have mostly disappeared, the expansionary policy enforced by the current presidential regime exists solely for the purpose of further economic expansion, regardless of the risks associated with extended growth measures.
The economic risk regarding expansionary policy comes in the form of over-inflation from excessive interest rate decreases. By forcing money into the market, consumers may purchase in excess now since saving will not benefit them, thereby forcing businesses to produce more and hire more. To maintain their profitability and customer base, businesses may have to increase prices to offset the demand increases, which pushes the economy into cyclical supply-demand inequality and inflation trouble.
A pure growth, conservative-led economy indicates that an expansionary monetary policy will push America towards a market-driven, business-promoting, capitalistic society. While America has historically favored capitalist tendencies, an economic structure that risks spiraling inflation and battering the lower class may face backlash from the public and left-leaning politicians, making its implementation extremely difficult. Nevertheless, any policy that brings America closer to a free-market system and economic efficiency will promote growth in both the short- and long-term; the social sacrifices for its use may, however, outweigh the benefits.
Contractionary policy, the alternative to expansionary policy, focuses on increasing interest rates to promote saving and force money out of the market. John F. Kennedy, Richard Nixon, and Jimmy Carter most recently implemented this typically democrat supported policy in order to slow economic growth and calm the spiking inflation rate, most likely cause by expansionary policy. President Nixon experienced a special case, similar but opposite to that of President Obama, as the over 6% inflation rate following Lyndon Johnson’s reign forced the republican to employ a “gradualist” monetary policy (effectively a renamed contractionary policy). Unlike President Obama, who most likely would have wanted contractionary policy, Nixon adamantly supported economic expansion, but could not effect this belief until late in his presidency due to economic conditions in the early 1970s.
While America has experienced a bull market for the past decade, many expert macro-economists foresee a downturn within the next few years. This somewhat forces the Fed to push current interest rates into contractionary territory to combat any inflationary trouble imposed by the recent expansion.
To many, contractionary policy seems counterintuitive because it deliberately shrinks the economy, and history has largely justified this belief as seldom has America seen as adamant contractionary pushes as it has expansionary. Further, economic developments over the past three decades have largely tamed Herb Stein’s “hydra-headed monster” of inflation, giving economists a bit more control over monetary policy (i.e. not having to react to over- or under- inflation). Further, former Fed chair Ben Bernanke blamed the Great Depression on contractionary policy, further reducing the public’s and politicians’ faith in the practice.
Despite such hesitation, America has seen spurts of contractionary policy, as mentioned above, but the reservations regarding full-fledged economic slowing have prevented contractionary policy from emerging in any significant capacity. If America spontaneously adopted contractionary policy today, the impending recession would likely come sooner than expected and hit harder as well. While economic contraction has the primary benefit of controlling inflation, the consumption decreases inherent in its use make it a debatable long-term policy.
The Fed’s choice of monetary policy has myriad effects on everyday life, with expansion promoting consumption and contraction encouraging saving. Without regard to political preference, economic policy specifically with respect to inflation and interest can push America towards the free-market capitalism foreseen by founding fathers and early entrepreneurs, or it can pull the nation towards the socialist policies advocated by many equality-driven organizations and politicians. While experts hold both of these opinions, Jerome Powell and his colleagues currently believe in an approximately 2% inflation rate and infrequent but occasional increases in the federal funds rate without approaching contractionary territory. With the options and arguments in mind, I hope you now have the information necessary to make an informed decision on what you believe best for American monetary policy.
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