Analyzingremarks by the Federal Reserve chair.
Thefollowing is an explanation of the Federal Reserve’s chair speechon MacroeconomicResearch After the Crisis.She is Janet L. Yellen. She delivered the speech during the 60thannual economic conference at Boston, Massachusetts, which wasorganized by the Federal Reserve Bank of Boston. In her speech, shetalked about the “Causes and Implications for Future Business CycleDynamics”. In this memo, I will be talking about a key point shespoke, TheInfluence of Demand on Aggregate Supply.(“FRB: Speech –Yellen, Macroeconomic Research After theCrisis—October 14, 2016,” 2016).
Sheexplained the point using the IS-LM (Investment Saving – LiquidityPreference Money Supply) framework. In this framework, she explainstwo intersecting curves of demand and supply. In theinvestment/saving (IS) curve, there is the change of theincome-expenditure method which brings together the interest rates ofthe market which represent demand. The Liquidity preference/ moneysupply equilibrium (LM) curve is a representation of supply or thefunds which is to be used for investment. (Casares& McCallum, 2015).
Thefirst question she poses is the difference between aggregate demandand aggregate supply. She questions if there are occurrences in whichvariations in the demand aggregate can result in persistent,appreciable impact on supply aggregate.
Shegoes further to explain that most of the economists before the GreatRecession would not have admitted that there are such circumstances.The economists might have mostly approved Robert Solow who claimedthat the output of an economy over a longer period of time is mainlycontrolled by supply, which the quantity of services and goods thatan economy can produce, when provided with capital and laborresources and the required technology. In contrast, she explains thataggregate demand is viewed as the explanation of short-term changeswhich surround the majority of exogenous longer run trends which aredetermined by supply.
Thisconclusion should be reconsidered when looking at the stage ofeconomic action to go back to its state before recession mode in theeconomies which are more advanced. The experience following crisisindicates that variations in the aggregate demand can have apersistent, appreciable impact on supply aggregate when there ispossible output.
Theopinion that continued shortcomings in demand aggregate maysignificantly impact the supply part of the economy is not modern.For instance, this possibility was debated previously in themid-1980s while referring to how European labor markets wereperforming. The concern in the topic has however raised recently dueto the continued decrease in the growth in economy which is witnessedin most developed countries from when the problems began. Most of therecent researches show evidence across the country suggesting thatserious and continued recessions had previously had those types oflong-term impacts, even recessions which seem to have originatedentirely or greatly from a shock to demand aggregate.
Accordingto one of the studies done in the U.S about the country’sexperience, it is estimated that the equivalence of possible outputis currently 7 percent less than the expected value based on thetrajectory before crisis. Most of the damage in the supply side isattributed to various developments that mostly occurred due to slowrecovery and deep recession. The study particularly indicates thatthe U.S experienced a reduction in the supply of labor when thecrisis began due to diminished immigration and the reduction inparticipation of labor force. This could not be demonstrated by thedemographic features or the cynical conditions. This led toabnormally slow growth of businesses capital summation because thecrisis had caused a great decline in the amount spent on developmentand research.
Alot of research should be done to understand better the effect ofvariations in aggregate supply and aggregate demand. Looking from apolicy perspective, there is a great need to remember that a monetarystance which is accommodative, if well maintained for a long period,can have costs exceeding the benefits by raising the financialinstability risk. The potential costs and benefits of following suchplans is very hard to account for, and some policies should be usedto tackle the loss to the economic supply side.
Readingthe minutes of the FOMC
Action taken by the FOMC regarding the level of the fed funds rate.
Thecommittee agreed to authorize and guide the Federal Reserve Bank ofNew York to perform transactions in the SOMA according to thedomestic policy directive which was released during the meeting. Thedesk was to take care of the open market activities as required so asto maintain the rates of the federal funds in the targeted range of ¼to ½ percent, involving the overnight reverse repurchase activitiesat a good rate of 0.25 percent. The Treasury should solely determinethe quantities to be held by the securities which have the authorityin the System Open Market Account which are availed for thoseactivities. ("FRB:FOMC Minutes, September 20-21, 2016," 2016)
TheDesk was allowed by the Committee to proceed in rolling over thesecurities of Treasury which were maturing and the auction andcontinue investing the payments which were principal on all theagency mortgage-backed securities and agency debts. The Desk was alsoasked to participate in the coupon swap and dollar roll transactionsthat were required to help in settling the agency mortgage-backedsecurities transactions belonging to the Federal Reserve.
Thesewere arrived at after looking at the outlook of the labor market, theeconomic activity and inflation while considering the outlook. TheCommittee did all this while trying to determine the size and timingof the adjustments to be done in the future so as to adjust theranges of federal funds rate. This will help in assessing the desiredand expected conditions of the economy.
Considering the Staff Review of Financial Situation which was discussed.
Theconditions of the domestic finance have been accommodative since thelast meeting. The prices of the assets have however changed within anarrow range during that time. The volatility has however raisedsince the market participants have turned their attention to thecentral bank for communications within the U.S and in othercountries. The markets are highly expecting the policy rate to raiseby the end of the year. ("FRB:FOMC Minutes, September 20-21, 2016," 2016)
Mostof the stock price indexes have moved down since the last meeting.Volatilities have been witnessed in different asset markets whichwere somehow low before the last meeting but have now increasedrecently. The graph below explains this relationship.
(Casares& McCallum, 2015).
Staff Economic Outlook. This is the view of the economic projection as seen by the economic specialists or those given the task of controlling the US economy. It is important because the government in planning the economy of the country. Once the workers create the economic projection for a certain period, since they create it using the prevailing conditions, they can easily know the progress of the country economy if it is heading in the right or wrong direction. They are also able to detect problems that may occur in the county’s economy and advise the relevant authorities accordingly. (MacAvoy, 2016).
Casares,M., & McCallum, B. T. (2015). Anoptimizing IS-LM framework with endogenous investment (No.w7908). National Bureau of Economic Research.
FRB:FOMC Minutes, September 20-21, 2016. (2016, September 21). Retrievedfrom https://www.federalreserve.gov/monetarypolicy/fomcminutes20160921.htm
FRB:Speech–Yellen, Macroeconomic Research After the Crisis–October 14,2016. (2016, October 14). Retrieved from http://www.federalreserve.gov/newsevents/speech/yellen20161014a.htm
MacAvoy,P. W. (2016). Advising the president of the United states on economic policy. Journalof Competition Law and Economics.