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Ohio Council on Economic Education Economic Policvr Issues for the 1990$ Akron, Ohio November 7, "1.990 W. Lee Hoskins I. Introduction A. As 1990 draws to a close, it has proved to be a very interesting and challenging one for the FederalReserve (the Fed lias not beeriwithout its critics) sis has caused people to look to monetary lx B. II. This afternoon,I want to respond to these obiections and argtre that the Fed should have a primary, overiiding responsibility - protectiõn of the value of the currency The Foundatio_n for Monetary Policy - The Federal Reserve Act A. Act of Congress 1. establishes a broad framework for conduct of monetary policy 2. calls for 2 policymaking bodies within the Federal Resérve a. seven member Board d in Washington, D.C. b. Federal Open Market Col , includes thé Board, President-of NY Fed, and 4 of the other 11. regional Reserve Bank ¡resi 2. B. "r:rl stments need to be made in the policy Goal for monetarv n 1. "maintain ldnþ commensurate i,, IIL Lessons ofthe 1970s and 1980s A. Found otrt that could not control o, -2- B. Importance of exnectations L. ^ correct expfanation of relationship between inflation and unemploytment depends on expeôtations of inflation 2. trading oÏf a little inflation for ieduced unemployment involves surprising people or violating expectations 3. and becaüsè qtiople will not 6e "fooled" indefinitely, repeated attempts for such a tradeoÏf will only result in inflation IV. Inflation is Costly and Leads to Recession A. B. Excessive inflation leads to recessions monetary policy that is too expansionary will eventually lead to a rise in the raÉebf inhation eventually the Fed must tighten that may lead to a recession 1. 2. Even 1. 2. 3. 4. V. resources devoted to protecting against inflation ís wasteful in that takes resources away-from procluõing real goods and services it The Oil Price Shock A. Many believe that monetary po becaûse it causes inflation ánd, 1.. all but one of the I rpost- 2. e shock oil price shock Iraq's irwasion of Kuwait and consequent UN embargo has seemed to touõh off another round prices a. soaring oil -stock b. declinðs in and bond prices c. renewedspeculationabout-economicrecession about the shock's impact on prices and cnsrs a. t, output declines because of fewer energy rlse th and income derived by wealth (decline alances) on their perception of the length of the if it is 1. 2. levels ry income loss nterest rates loss to correspond with smaller budsets and reafinterest rates relativelliunchanged -3- C. How 1. ary policy react? pérèeiveä as a short term effect (expected real interest the case during the Iranian revolution (7979) and raq war (1980-81) to brine interest rates down tempoíary and the Fed does not eveñtualþ return to the 2. If the sho e an reversed a. this ongoing phenomenon, not soon to be est rates do irõt rise) b. c' 3. VI. available In fact, an easing monetary policy will only exacerbate the situation Past Reactions to a Slowing Economy A. B. - The Inflation-Recession Cycle The economy is slowing and there are pressures for the Fed to ease monetary policy How should mone-tary policy react? -- Above all else, should protect the long-term value of thé c-urreñcy -- price stability or zero inflation xist? will always exist that the Fed cannot do monetary policy not have recessions induced inate it VII. Appropriate Objective for Monetary Policy --Zero Inflation A. inflation rate of zero will reduce any uncertainty associated with inflation B, credibility in the Fed's policy is important since expectations can olav a powerfufrole; unforturiately, credibility can only b^e established oieí time (not everyone will understand whyinflation is4%o) :",t¡j:ttt;?i,äS*g""åltii"' -+ MII.Conclusion A. B. Accept the limitations of discretionary monetary policy It is time to dismiss the wrongheaded notion that money should be thrown at our problems 1. ' oil shock 2. sluggish growth C, We legi 1.2. overriding goal of p W for the Federal Re riment conducive to a th
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