California State University Northridge Economic for Managers FOMC Paper: Economics Answers 2021

California State University Northridge Economic for Managers FOMC Paper: Economics Answers 2021

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California State University Northridge Economic for Managers FOMC Paper

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Economics for Managers
Case for Analysis
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.?
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 addi-
tional $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 purchas-
ing 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. 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 addi-
tional accommodation as needed to promote a stronger eco-
nomic 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.? 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.
Jon Hilsenrath and Kristina Peterson, ?Fed Holds Rates Steady,
but Outlook Shifts,? Wall Street Journal (Online), April 26,
2012
2Kristina Peterson and Jon Hilsenrath, ?Fed Warns of Risk to
Economy,? Wall Street Journal (Online), June 21, 2012.
Jon Hilsenrath, ?Fed Moves Closer to Action,? Wall Street
Journal (Online), July 25, 2012; Sudeep Reddy, ?Gauging the
Triggers to Fed Action,? Wall Street Journal (Online), August 1,
2012.
Board of Governors of the Federal Reserve System, Press
Release, August 1, 2012. Available at www.federalreserve.gov.
?Jon Hilsenrath and Kristina Peterson, ?Wary Fed Is Poised to
Act,? Wall Street Journal (Online), August 2, 2012.
361

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