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Monetary policy

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Monetary policy

Savannah Kimble '18

Savannah Kimble '18

Savannah Kimble '18

Spencer Payne

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The United States unemployment rate is down to five percent, according to the Bureau of Labor Statistics. This is positive for the economy—no one would dispute that. But the fact that some suggest that the falling unemployment rate will prompt the Federal Reserve to raise interest rates is concerning.

There is much more to the interest rate discussion than domestic figures such as the unemployment percentage. When discussing whether the Federal Reserve will raise rates next month, the state of global commerce must be front and center.

Americans seek growth and they pride themselves on achieving it. After all, the “American Dream” was born here. But now many are frustrated with the Federal Reserve System.

They argue that allowing momentum to build toward a sharp increase in inflation by continuing to hold down interest rates is inappropriate given the economy has strengthened in recent months.

Often, these critics sound convincing. Pointing to the unemployment percentage and healthier financial markets, they call for the Fed to raise interest rates.

But while these people are correct—the economy has improved dramatically since mid-summer—they often forget that the U.S. economy does not operate in a vacuum. It is linked to other nations.

The international arena impacts the application of monetary policy because trade directly influences the state of the U.S. economy. U.S. economic growth will slow, for example, if its export levels decrease. So when making monetary policy decisions, it is important to consider the state of global commerce.

But there is more to the story than that. Exports levels can decrease for two reasons.

First, if international economic conditions are declining, entities outside of the United States will demand fewer U.S. exports. They will simply have less aggregate income to spend on U.S. goods and services. It is important to note that this export reduction is outside of the United States’ control.

And second, the Fed can decrease demand for U.S. exports based on the monetary policy it chooses to enact. When the Fed raises interest rates, the dollar appreciates and makes U.S. goods and services relatively more expensive in the global market. This decision, like declining global economic conditions, also generates a drag on the U.S. economy by reducing exports.

With this in mind, consider the global economic conditions that the United States faces today. China has historically served as one of the United States’ largest export markets, importing nearly $124 billion in U.S. goods and services last year, according to the Census Bureau. But as of late, the Chinese economy has contracted. Its stock exchange index has dropped 42 percent in the last five months.

It is therefore imperative that China’s recent economic downturn be factored into the monetary policy discussion. The fact that the Chinese economy is slowing means that the Chinese are importing fewer U.S. goods and services. Thus, U.S. exports are decreasing and U.S. economic growth is being held back.

So even though U.S. markets are trending upward, the unemployment rate is falling, and consumer spending is increasing domestically, U.S. economic growth is not moving too quickly. China is slowing it down so the Fed does not have to.

For if the Fed moves to raise interest rates, savers around the world will find lending in the U.S. more attractive because of the higher U.S. interest rate. This would lead these global savers to exchange their currency for dollars so they can lend in the United States.

As they seek more dollars, they will drive up the dollar’s effective value—making U.S. goods and services more expensive to entities outside of the United States and thereby reducing the demand for U.S. exports even more.

Does that sound like a good idea given the current state in of the Chinese economy? Would the Fed really want to enact policy that would make some U.S. goods and services prohibitively expensive to one of the United States’ largest export markets?

We will find out next month. But in the meantime, should you choose to examine monetary policy, I urge you to look past domestic statistics and consider the economic conditions abroad.

The Fed is better off waiting a bit too long before slowing the economy down than slowing it down too early,” Economics Professor Art Goldsmith said. And I tend to agree.

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2 Comments

2 Responses to “Monetary policy”

  1. John Thomas on November 18th, 2015 9:56 am

    Great theory if you do not take into account some of the unintended consequences of an extended zero rate Fed policy. What about a growing population of retirees that prudently relies on investment portfolios weighted heavier in near zero interest bonds? What happens if our economy begins to fall into another recession and interest rates are still at zero – does the Fed go to negative interest rates (the Fed will look pretty stupid with no “bullets in their gun” if monetary policy is to be considered a recession fighting tool)? Look at Japan to see what the prolonged fantasy of zero interest rates does to an economy. We are in “la-la land” right now with zero interest rates, need to take our medicine as tough as it will be, and come back to reality. The longer we wait, the more painful it will be.

  2. George on November 19th, 2015 6:58 pm

    Great article!

If you want a picture to show with your comment, go get a gravatar.




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Monetary policy