Introduction
Macroeconomics studies phenomena that affect the wide economy, such as inflation, economic growth rates, and gross domestic product (GDP). There is an increasing interest in the U.S. Federal Reserve due to spiraling inflation. With consumers anticipating high inflation, the Federal Reserve is moving to curb price level changes even at the cost of economic growth. It is essential to evaluate the Federal Reserve’s history and objectives and how it responds to inflation.
Article Selection, Federal Reserve History, and Purpose
The selected article is Jeanna Smialek’s on Federal Reserve’s highest rate increase in nearly twenty-eight years. The article explores the most recent interest rate hike by the Federal Reserve to curb persistent and rapid inflation (Smialek, 2022). The interest rate was raised by 0.75 percentage points, signaling that the Federal Reserve is ready to sacrifice economic growth to achieve price control. A Congressional Act created the Federal Reserve in 1913 as policymakers agreed that a central bank was needed in the U.S. Before it was established, the U.S. experienced multiple financial crises. One bank’s failure would create a domino effect, where other bank customers would rush to withdraw their money. Therefore, banks required a source of emergency reserves to avoid panic. The 1907 panic severely affected the U.S. banking system, prompting Congress to create the Federal Reserve and stabilize the American banking system (Arnold, 2019). Since then, the Federal Reserve has evolved to assume more responsibilities as financial markets constantly change.
Federal Reserve’s Objectives and Current Actions
Congress tasks the Federal Reserve to achieve three specific objectives. First, the Federal Reserve’s actions must ensure maximum employment for the nation’s population. Second, the Federal Reserve should act to maintain the stability of prices to improve consumer and investor confidence since a currency’s purchasing power is not eroded easily. Finally, the Federal Reserve should moderate interest rates in the long term (Arnold, 2019). The Federal Reserve is currently using contractionary monetary policy to control skyrocketing prices of goods by reducing consumer demand. In addition, high-interest rates will compel firms to produce less, making it impossible to raise prices. Ultimately, when the Federal Reserve raises interest rates, the likelihood of further tightening of monetary policy reduces inflation expectations.
Business Cycles and Policy Tools
The Federal Reserve’s actions are impacted by contraction and expansion. It uses expansionary monetary policy for economic strengthening during troughs or contractions. For example, the Federal Reserve can decrease interest rates in economic shrinkage to stimulate economic output. In contrast, the Federal Reserve utilizes contractionary policy during expansions or peaks. For instance, it can lower interest rates to end expansions. Several policy tools are used by the Federal Reserve, including open market operations, reserve requirements, reserve interest, and the discount rate. Open market operations occur when the central bank sells or buys securities. The method is frequently used to control the federal funds rate. When the Federal Reserve buys securities, cash is added to its reserves, giving banks more money for lending, which leads to expansion (Arnold, 2019). In contrast, the Federal Reserve sells securities when it wants to tighten monetary policy.
Higher Price Levels and Course of Action
The Federal Reserve contributes to higher prices after lowering the federal funds rate. Thus, borrowing money will cost less, meaning that people will increase their spending. As demand for services and goods increases, the prices of commodities increase. The Federal Reserve should pursue a contractionary monetary policy by increasing interest rates (Smialek, 2022). The interest rate rise will make borrowing more costly, reducing commodity demand. In addition, the Federal Reserve can sell securities in open market operations to banks’ cash holdings.
Conclusion
In conclusion, the Federal Reserve’s significance is reflected in its history and efforts to maintain price stability. Inflation has struck the U.S. economy, and Federal Reserve has increased interest rates by the highest percentage points since 1994. The Federal Reserve strives to control prices and interest rates. It can use different policy tools, with open market operations being the most used due to the Federal Reserve’s effectiveness in controlling the federal funds rate.
References
Arnold, R. A. (2019). Economics (13th ed.). Cengage Learning.
Smialek, J. (2022). Federal Reserve takes swing at inflation with largest rate increase since 1994. New York Times.