Macroeconomic Case Studies Essays - Inflation, Price Indices

Macroeconomic Case Studies Economics 001A: Macroeconomics Macroeconomic Case Studies Stephen Rossi Economics 001A: M 6:30-9:15 Slowing the US Economy The article titled 'Fed Unlikely to Alter Course' by John M. Berry of the Washington Post takes an interesting look at actions that Alan Greenspan his colleges of the Federal Reserve have been taking over the last 9 months to slow the economic growth of United States. The astonishing growth rate of 7.3% is fueled by an economy that is in the midst of a high tech revolution. The article also explores the contrasting view of other economists that say that the Fed has increased interest rates too much in its attempts to slow the economy. The means by which Alan Greenspan and the Federal Reserve have chose to slow the economy is through a monetary policy, or more specifically, an increase in the national interest rate. The article states that the Fed officials have come to a broad agreement that they will keep raising the rates until growth slows to a more sustainable pace to make sure inflation stays under control. Because of the booming economy and the investment in the stock market the exchange of money has increased for goods and services, which in turn increases the price level or the quantity of money demanded. By increasing the interest rates the Fed commits itself to adjusting the supply of money in the United States to meet that rate at a point of equilibrium. If the interest rate is increased, less goods and services are demanded, and therefore will slow down the economy and reduce the rate of inflation. The article points out that as stock prices have risen over the last couple of years, so have American ho usehold wealth and consumer spending. This is precisely the cycle that Fed officials want to interrupt to slow growth before it fuels more inflation. At the time this article was written the stock market prices had fallen sharply especially in the technology sector. But the Fed continued on the path to raise interest rates further noting that the index that they closely follow and contains a broader rage of public traded US stocks, the Wilshire 5000, is up for the year. Even though they began raising rates gradually 9 months ago, it takes almost a year for the economy to feel the full effects. In this case the results of the interest rates increased could be felt as last as the second half of 2000. Yet the economy has not slowed down, and the demand for goods and services continues to increase as wealth does. One of the ideas that has been presented to Greenspan by the fed officials was to take bigger steps in raising the interest rates. They feel that this will decrease the money demand in a quicker fashion. In turn these actions will lead to lower consumer spending, and thus decrease the inflation rate. However, because of the erratic patterns in today's high tech economy Greenspan is expected to stick to his pattern of more gradual increases to the interest rate. Eventually when monthly loan payments increase enough, consumers will back on purchases and investments. The article points out an example where the rate for a new 30 year fixed-rate home mortgage is up to 8.5% from 7.75% nine months ago in June. In the situation of a $150,000 home loan, this new interest rate will add almost $100 to each monthly payment. Over time the full effect of the interest rates will be felt. One economist, James Glassman of Chase Securities takes a different look at the new interest rate. He points out that the rates that the Fed has set are fairly high in comparison to the rate of inflation as it is currently in the United States. The formula that Glassman follows examines the inflation rate when food and energy items are excluded because they are so volatile. With these items removed the rate of inflation in the US is less than 2%. As with other measurements, this rate can be subtracted from the interest rates to find a 'real' interest rate which consumers a paying. So in terms of 30-year home mortgage rate set at 8.5%, only 6.5% of it is