Monetary policy is in the news today. The Federal Reserve Board cut the federal funds rate and the discount rate today by large margins. Each by half a percentage point.
This was the first time the federal funds rate was cut in four years and the first time since Ben Bernanke became chair of the fed.
Both actions reduce the cost, to banks, of borrowing money, and in turn affect the amount that they then charge you and I in interest rates on credit cards, car loans and home mortgages.
Their actions are an attempt to infuse cash (liquidity) in to the economy following the collapse of the subprime mortgage business. It also provides an indication to the business community how the fed under Bernanke will act in the future when faced with financial issues. The rates had risen in small increments over the past four years, which indicated that the fed was worried about an overheated economy that could become inflationary. The chief concern right now is recession.
The markets do not like uncertainly. Once they figure out the behavior of a fed chairman (like Alan Greenspan) they tend to want to keep them in place so they know what to expect when they are called to make a decision. Chairman tend to hold on to their jobs for 10-15 years, which allows a degree of stability to the economy. Now they have their first indication about what Bernanke is inclined to do.
1--Give a clear statement regarding the fed's intent ("The tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time."
2--And make a significant change that will make it less likely that further changes are necessary.
Both are different than the activities of his predecessor who was famously cryptic in his statements and gradual in his rate cuts or increases.
When we cover the fed and economic policymaking in the last section of 2302, I try to point out that an advantage of monetary policy as a macroeconomic instrument is that it allows for quick response to changing economic circumstances. The fed already has statutory authority to raise and lower rates and so we don't have to worry about the politics associated with congressional action.
