Federal Reserve
The main purpose of the Federal Reserve (Fed) is to preserve the long-term stability of the country’s financial growth. The Fed achieves this goal by manipulating interest rates, managing the money supply, and regulating the markets. This involvement in the country’s financial position leads to changes in the economy and its indicators, including the GDP. The general way the Fed inadvertently can influence the GDP is through the manipulation of the interest rates (Svensson, 2020). However, the general purpose of the Fed is not to adjust the GDP figure. The Fed changes the interest rates to control growth or slow down the economy, avoiding recession or hyperinflation. Thus, when the financial indicators show the possibility of either recession or hyperinflation, the Fed modifies the interest rates from its normal rate of three percent to avoid them. In other words, it applies countercyclical monetary policies to control the situation. As a result, the economy and GDP can, in theory, fluctuate under the changed conditions and with a new interest rate.
Aside from the extreme hyperinflation and recession, the Fed also commonly uses countercyclical monetary policies to avoid negative consequences from the business cycle that can affect the GDP. The Fed’s procedure to combat hyperinflation and recession is similar to their adjustment of the business cycle. When the Fed lowers the interest rates to avoid hyperinflation, it slows down capital investment and raises household consumption. In other words, for regular people, it is profitable to consume more and take on the debt with lower interest rates. On the other hand, the investors see the lower returns on their capital investments and prefer to decrease their financial activity. Thus, in theory, the Fed intends for GDP to stay stable, and it can fluctuate but not to an extreme degree under the proper implementation of monetary policy. Moreover, with the stability of GDP, this countercyclical monetary tactic effectively regulates the business cycle, as these small changes combat the negative outcomes from its swings. In other words, the Fed’s policy guarantees economic stability, balancing growth factors like GDP and mitigating the effects of business cycle swings.
Government Intervention
Government interventions can lead to positive and negative consequences. As mentioned before, if the policy is applied properly, it can stabilize the economic situation. However, in the opposite case, it can lead to disastrous consequences, as other factors can be at play. One example of such an external factor is Nixon’s Oil Crisis. During that period, President Nixon froze wages and prices to combat inflation and prevent hyperinflation. In theory, it should have had stabilizing effects. However, after the controls were gradually lifted, the inflation persisted, contradicting the intention to curb it in the first place. The reason was that external factors like US major oil dependency were not accounted for in the primary decision-making process. The solution should have also included the active and urgent steps to find other oil sources and mitigate the overall US oil dependency. After that, the US acquired more oil supply, negotiating with Saudi Arabia, but its oil dependency still persists, as seen in the recent economic fallout.
The current crisis again shows the little long-term effect of the government intervention. The Fed cautiously raises interest rates to stop inflation. Even though, because of the COVID-19 pandemic, inflation could have been easily predicted and mitigated, the war in Ukraine exaggerated the economic crisis. As a result, the US decided to close the Russian oil channel, leading to a more severe economic downturn with oil prices skyrocketing. The Fed now faces a contradictory situation, which can lead to a recession or increased inflation if it is not cautious of its actions. However, this situation would not have been as difficult if the US had actively sought ways to stop its overreliance on oil after the Nixon Crisis with a solution including alternative green energy sources (Rudebusch, 2019). However, the current situation shows that the Feds are bound to fail in one way or another if urgent action is not taken.
References
Rudebusch, G. D. (2019). Climate change and the Federal Reserve. FRBSF Economic Letter, 9. Web.
Svensson, L. E. (2020). Monetary policy strategies for the Federal Reserve (No. w26657). National Bureau of Economic Research.