The Politics of the Money Supply

The Story:

The US Federal Reserve has received a lot of criticism in recent months for what many see as an overly rigid stance toward the money supply and interest rates. Some of that criticism comes from President Trump, who has said that the US economy would “go up like a rocket” if only the Fed would ease up on rates.

Background:

The Federal Reserve in effect determines the supply of US dollars in circulation, and it has a lot to do with (though its decisions aren’t the only factor in) interest rates, which are the prices of borrowing dollars, whether the borrowers are banks, industrial firms, or consumers.

In simple terms, when the economy seems to be prone to inflation, it is the duty of the Fed to throttle back on money supply growth and encourage higher interest rates. On the other hand, when inflation is not a risk, and the economy needs productive stimulus, the Fed can supply that stimulus by “quantitative easing” and lower rates.

The Thing to Know:

The Fed’s target rate is 2% inflation. Inflation has for some time now been below that target. So the President may have a point: why, indeed, should rates not be lowered? Defenders of Fed policy, on the other hand, are generally old enough to remember the 1970s, a time of roaring inflation that did not succeed as stimulus, and they are wary of a repeat performance.

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