The Fed Can’t Fix the Economy?

Jennifer Horlick – Honorbound

From what we learned in Chapter 10 of Naked Economics by Charles Wheelan, the Federal Reserve has the power to make a direct impact on the economy through regulating the country’s money supply, which either increases or decreases interest rates. The Fed has to find the right balance of money supply, or the “speed limit,” according to Wheelan[1], that helps the economy grow without causing inflation, but most of the time inflation cannot be avoided. When interest rates are low, people tend to borrow more money because they do not have to pay as much interest over time. More borrowed money leads to more spending, which forces producers to expand their production. Once producers cannot find the means to produce more, which is inevitable with a quickly growing demand for the products caused initially by low interest rates, they must raise the prices of their products. Eventually, all producers in the US economy will have to increase their prices due to low interest rates and inflation occurs.

Stanley Fischer, Vice Chair of the Federal Reserve, states that since US interest rates are low, the economy will be sluggish during the upcoming years. He claims that the Fed cannot simply raise interest rates because outside factors currently affect interest rates. According to Fischer, the four main reasons for the currently low interest rates are slowing global growth, Baby Boomers retiring (and therefore fewer workers), less business spending, and a lack of great innovation since the Internet.[2] What can the Fed do if the US economy’s future looks bleak and raising interest rates will not make the economy’s future look better?

While the Fed cannot completely prevent the oncoming of inflation or a sluggish economy, it can soften the blow. Theoretically, the Fed could put more money into the system, but that would also cause inflation because the prices of everything, as well as wages, would increase. Furthermore, pumping more money into the economy would not prevent people from borrowing money because interest rates would still be low. It seems like there is not much that the Fed can do to prevent inflation even though they have the ultimate power to make changes in the economy.

Before I learned about the Fed in Naked Economics, I assumed that inflations and recessions were the mistakes of the government. In my mind, economics and politics were not separate things, but now that I know more about the US economy and government, I understand that the two are detached from each other. Inflations, recessions, and deflations usually are not errors on anyone’s part; the economy functions in a random cycle. The US economy can prosper and then promptly fall into a recession period, such as the change from the thriving 1920s into the Great Depression. Not one single factor contributes to the cycle of the economy but a combination of many outside forces. The Fed exists to regulate the economy as much as possible, even if its cycle is unpredictable.

[1] Wheelan, Charles. Naked Economics. New York, NY: W.W. Norton & Company, 2002.

[2] Gillespie, Patrick. “Top Fed Official ‘very Concerned’ about U.S. Economy.” CNN Money. October 17, 2016. Accessed October 18, 2016. http://money.cnn.com/2016/10/17/news/economy/federal-reserve-fischer-concerned/.

“Auditing the Federal Reserve.” Sound Money Defense League. 2016. Accessed October 20, 2016. https://www.soundmoneydefense.org/audit-the-federal-reserve.

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