Fed's Rate Cut Decision example essay topic

U. S Monetary Policy in 1995 When Alan Greenspan presented the Federal Reserve's semi-annual report on monetary policy to the Subcommittee on Domestic and International Monetary Policy, the Committee on Banking and Financial Services, and the U.S. House of Representatives on February, Dr. Greenspan touted a cautionary yet favorable view of the U.S. economy. He states that 'With inflationary pressures apparently receding, the previous degree of restraint in monetary policy was no longer deemed necessary, and the FOMC consequently implemented a small reduction in reserve market pressures last July. ' (Greenspan, 1996, Speech) During the Summer and Fall of 1995, the economy experienced a strengthening of aggregate demand growth. According to Greenspan, this increase in aggregate demand brought finished goods inventories and sales into near equilibrium.

The Fed's fine tuning of the economy seemed to be paying off. Greenspan had a positive outlook for the economy for the rest of 1995. H estates 'the economy, as hoped has moved onto a trajectory that could be maintained -- one less steep than in 1994, when the rate of growth was clearly unsustainable, but one that nevertheless would imply continued significant growth and incomes. ' (Greenspan, 1996, Speech) Towards the end of the year, the economy showed signs of slowing. Fearing a prolonged slowdown or even a recession in the economy, and with inflationary expectations waning, Chairman Greenspan and the Federal Reserve cut rates again in December. (Greenspan, 1996, Speech) There are, of course, critics of 1995's monetary policy.

Most of the criticism came in the early part of 1995 when the Fed raised rates again. In the article 'Are We Losing Altitude Too Fast' from the May 1, 1995 issue of Time magazine written by John Greenwald, he explains that the economy might not be coming in for a 'soft landing' like the fed predicts. Trying to sustain 2 to 3 percent growth might lead us into a recession. Mr. Greenwald explains how the Fed's actions in 1994 and early 1995 has hurt individuals and the economy as a whole. 'Corporate layoffs are far from over,' says Greenwald,' they generally accelerate when firms find themselves in an economy that is weakening. ' (Greenwald, Time, 5/1/95, p 80) Unemployment and layoffs aren't the only thing to worry about according to Mr. Greenwald.

The automobile industry and the housing markets are both getting hit in the pocket books. Paul Speigel, owner of a New York car dealership explains his woes by saying 'We " re doing our best to keep up the volume by discounting, working on our customers, but the Fed's rate hikes have dampened the ability of many Chevrolet customers to buy that new vehicle. ' 'John Tuccillo, chief economist for the National Association of Realtors states that the market (for new housing) 'fell apart as mortgage rates rose above 9%last fall (1994), and still have not yet recovered. ' (Greenwald, Time, May 1, 1995. p 81) Another outspoken, and cynical opponent to the Fed's monetary policy is Dr. Michael K. Evans, who is president of Evans Economics, Inc. and Evans Investment Advisors, Boca Rot on, Fla.

Dr. Evans wrote an article in the Aug. 21, 1995 issue of Industry Week entitled 'The Gang that Wouldn't Shoot Straight: Fed's Trample Over Their Own Rate Cut. ' Dr. Evans contends that lowering the federal funds rate in July was a mistake because the economy was already starting to recover without tampering by the Fed. He claims Greenspan knew full well that the economy was on the upswing, but cut rates anyway to try to ensure his reappointment come March 1996. Dr. Evans claims that vice-Chairman Alan Blinder also knew of the recovery but 'he could not face his colleagues at Princeton when he returned, unless he pushed for a rate cut. ' (Evans, Industry Week, Aug. 21, 1995. p 122) Dr. Evans concludes that the Fed's actions in July were 'purposely misleading, cravenly political, and just plain stupid. ' (Evans, Industry Week, Aug. 21, 1995. p 122) Many people applauded the actions of the Fed in 1995, and defend them from the rampant 'fed-bashing'.

One of the defenders of the Fed's monetary policy and Alan Greenspan is Rob Norton who wrote an article in the July 24, 1995 issue of Fortune entitled " The Blaming of Dr. Greenspan. (Federal Reserve Board Chairman Alan Greenspan Takes Blame for Economic Downturn). ' Mr. Norton agrees with Greenspan that in February 1995 it was essential to raise interest rates because of an unsustainable rate of growth. He says that Greenspan was ahead of the game by doing this. 'The conventional wisdom crowd claimed that here was no reason to fear that the economy was going to overheat,' he goes on to say 'By the fourth quarter of last year, real GDP was growing at a 5.1% rate -- twice the average growth rate most economists consider sustainable in the U.S., given population growth and productivity increases.

' (Norton, Fortune, July 24, 1995. p 39) Mr. Norton also does not believe that Alan Greenspan cut rates in July to ensure his re-nomination in March, 1996. He points out that during the 1988 Presidential campaign, with inflationary pressures present, many economists felt Greenspan would not raise rates because he is a loyal Republican, and he did not want to hurt the Republican's chances in the campaign. Chairman Greenspan went against most people's predictions and raised rates 'just days before the Republican convention. ' (Norton, Fortune, July 24, 1995. p 39) Another defender of the Fed's policies during 1995 is Michael Sivy, who is a chartered financial analyst and a former Wall Street research director, wrote an article titled 'The Fed's Rate Cut Decision could Push The Dow to 4900 and Postpone a Recession,' which appeared in the Aug. 1995 edition of Money magazine. He stated that Greenspan 'decided to send businesses and consumers a clear signal: Interest rates won't go any higher. ' But Greenspan still was on the lookout for any inflationary pressures, so he reduced rates by a very small amount in July, which will be followed by more small rate cuts.

Mr. Sivy states " With the Fed fine-tuning the economy like that, we think the Dow could tack on another 200 points to top 4900 by year-end. ' (Sivy, Money, Aug. 1995. p 160) Through my research on 1995 monetary policy, I feel the Fed did a good job of monetary policy during 1995. During 1994 and early 1995 I believe the Federal Reserve were justified in their actions in stepping up interest rates. Inflationary pressures were definitely present at the time, and if the fed let the inflation occur, how high would they let it go? This might also mean going through disinflation in the future, which is a long and painful process. The Fed did the right thing by not even letting inflation 'out of the bottle.

' As for the Fed's cutting of interest rates in the middle and latter parts of the year, I believe the data suggests the economy was slowing down, along with that, inflationary expectations were fading also. This made it relatively easy for the Fed to lower rates. But they made sure they watched inflationary pressures at the same time. I still haven't made up my mind whether Greenspan based part of his decision to cut rates on political reasons or not.

Sure, he could probably make 10 times more in the private sector, but I believe more goes into it than that. Many people see the Chair of the Federal Reserve as the 2nd most powerful person in the U.S. right behind the President, this in itself could persuade Greenspan into pleasing the President who reappoints him. Another point would be going down in history. If Greenspan successfully obtains an unprecedented third term, he will probably be highly regarded in every history book yet to be made; it's doubtful that Greenspan would go down in history if he were the president of the Chase Manhattan Bank. As Rob Norton defended Greenspan in saying that he raised rates even though the Presidential election was just around the corner in 1988; Greenspan was only in the 2nd year of his 4 year term, so there wasn't any substantial political pressure, he still had about 3 years left of his term. At any rate, I believe that the Fed had a very successful year of monetary policy.

The stock market soared, inflation and unemployment are bo that respectable levels, so I just hope the Fed keeps it up, and President Clinton re-appoints Alan Greenspan.