US Monetary Policy Essay Research Paper US

U.S. Monetary Policy Essay, Research Paper

U.S. Monetary Policy

Economic policy dictates the lives of many people. Economic regulation affects everyone, if the economy falters then people lose money, inflation runs rampant, and unemployment rates rise. Controlling U.S. monetary policy, or at least having some influence, ranks high on the agenda of many political actors from the president and Congress, to the private sector like the credit industry.

At the heart of U.S. monetary policy is the Federal Reserve System. The Federal Reserve controls the money supply to member banks, and the interest rates that money can be lent and borrowed at. They also can control the money supply through open market sales on a much smaller level, but interest rates and reserve requirements are the big tools that the Federal Reserve uses to control the economy.

A basic explanation of the functions of the monetary policy tools is necessary at this point so the positions of the actors and political ideologies can be understood. This purposes of these tools can best be explained by Paul Peretz:

Monetary policies determine the amount of money and credit that is available in a society. When the amount of money and credit is reduced, the price the borrowers have to pay for money (the interest rate) goes up. When the money supply is increased, the interest rate is driven down. People borrow more when the interest rate is lower; they use the borrowed money to purchase goods, such as cars and houses, and invest in machinery and factories. Thus, increasing the money supply stimulates the economy. Of course, beyond some point the economy can be overstimulated. With more money in their pockets, people bid up the prices of goods and the result is inflation. Reducing the amount of money available to borrowers tends to depress the economy and slow inflation (Peretz, 267).

This explanation, however basic, does not account for the minute margin of error involved in controlling the economy. That is why the Federal Reserve only acts when it feels incredibly compelled to redirect the economy.

The Federal Reserve acts as an independent agency. Its members serve comparatively long terms and are politically insulated to a certain degree. My previous paper touched upon the debate over whether something so important as economic stabilization should be controlled by a body that is so independent. This can be related to the ideological differences between the parties and their beliefs on monetary policy.

The Democratic Party typically wants lower interest rates. They are willing to risk inflation for economic growth. This is most historically prevalent during the Great Depression. Massive government spending to stimulate the economy and lower astronomical unemployment rates came under Franklin Roosevelt, a Democratic president.

On the other hand, Republicans want higher interest rates because they focus on controlling inflation. Most Republicans think that through mildly depressing the economy, the end result is a steadier growth and a more stable economy. The above descriptions of basic party philosophies tend to be a little misleading; neither party wants to destroy the economy. They are both on the same page, however they polarize that page with the separation in views. Remember stimulating the economy through interest rates is a powerful resource for the Federal Reserve, and a small change can produce a gigantic outcome in the economy.

The president could quite possible be the most visible actor in the struggle for control of the economy. To most Americans, the president is the one who controls the government, which is true to a certain extent since we have moved from and era of Congressional government to Executive Branch leadership. The president is very powerful, but with this power comes accountability. When the economy is poor, then voters hold the president responsible. Anyone with any knowledge in political science knows that to the average voter, the economy is the largest determinant of voting.

This is the reason behind Edward R. Tufte s theory on political control of the economy. Tufte thinks that Presidents try to pump up the economy before elections, especially incumbents. The purpose of this is to gain electoral support going into the polls. Both parties have different methods for achieving their goals. Republicans typically depress the economy prior to the election then take the brakes off. Democrats try to stimulate the economy previous to the election. Both ways have the same goal, to increase the amount of disposable income.

Many people ask why the President would attempt to control the economy when it is such a risky task. Well, the reward is glorious. Strong electoral support is the prize for the party who masters control over the economy. The phenomenon of presidential influence over monetary policy is known as the political-business cycle (Tufte, 1994). However, the amount of influence the president can exercise is questionable. He has no direct influence other than through his appointments, and the only one he can appoint with certainty is the Chair of the Federal Reserve Board (appointed every four years). The Chair, the most powerful member of the Federal Reserve, meets with the president on a regular basis, and a certain amount of loyalty can be assured. The president has the best of both worlds