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Stuff the Fed says

Grace Concelman | Wednesday, February 15, 2012

The Federal Reserve. Ben Bernanke. Monetary Policy.

You’re probably about to stop reading this column because it sounds about as exciting as your freshman philosophy lecture. But, if you think what the Fed says only matters to the wannabe bankers in Mendoza preparing for Wall Street interviews, you might want to read on. Monetary policy affects businesses, your parents and, yes, even you.

But first, what exactly is the Federal Reserve?

The Federal Reserve is the central bank of the United States. Its responsibilities range from regulation to providing banks with financial services, but one of its main tasks is to conduct monetary policy, which means it controls the supply of money. The Treasury prints cash, but the Fed gets to decide how much of it should be circulating in the economy.

Controlling the supply of money certainly makes monetary policy sound a whole lot sexier, doesn’t it? And Bernanke, the current Chairman, only adds to the effect. (For the record, I’m kidding, although he does have a great beard.)

But does monetary policy really matter to you?

Well, do you buy things? Do you want a job someday? Do you eventually want to take out a mortgage or car loan?

Monetary policy affects all of these things. The Fed manages employment, inflation and how much money is in the economy by influencing interest rates.

If the Fed increases the money supply, the unemployment rate declines, but inflation and interest rates rise. If the Fed decreases the money supply, the unemployment rate rises, but inflation and interest rates decline.

Ideally, there is a delicate balance: employment is high, inflation is stable and interest rates are moderate. However, in extreme situations where the economy is expanding or contracting, the balance is thrown off, and the Fed must intervene.

Since the crisis in 2008, there has been some unprecedented intervention.

The latest mechanism the Fed is using to jump-start the economy is a new communications policy. The goal is clarity, but even clear communication sometimes needs a little interpretation. Here are some excerpts from the Jan. 25 statement by the Federal Open Markets Committee:

“While indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated.”

Thanks, Ben, you didn’t have to tell us that the job market hasn’t fully recovered.

Although the national unemployment rate has declined to 8.3 percent from as high as 10 percent in 2009, the rate for people aged 20-24 is higher at 14.2 percent. Good luck with that job hunt, seniors!

“The Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent.”

The target federal funds rate is the mechanism through which the Fed influences other interest rates. Reducing the rate encourages borrowing, which facilitates the flow of money throughout the economy.

It’s like when your professor curves a test to boost everyone’s grade. The curve allows more people to pass, increasing confidence. Of course, the danger is grade inflation.

“Inflation has been subdued in recent months, and longer-term inflation expectations have remained stable.”

Oh good, inflation isn’t an issue, so Professor Bernanke can keep on curving away.

However, barring extra credit, a curve can only go down to zero. It’s the same with interest rates. Since zero is as low as the target rate can go, this tool has been less effective, which is why Bernanke is enacting the new communications policy to tell us that these rates are going to be low for a very long time.

The hope is that increased communication and transparency will help the public manage expectations about the future, reduce economic uncertainty and facilitate decision-making. If you know ahead of time what the curve on a test is going to be, it affects how much you study.

“The Committee expects to maintain a highly accommodative stance for monetary policy … and currently anticipates that economic conditions … are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

Despite a generous curve, the economy is still collectively doing pretty poorly. So, now Professor Bernanke is telling us that he’s going to keep the curves coming until the economy starts passing. Actually, more than just a curve, he’s going to throw in a couple of review sessions, too, just to make sure that he’s being perfectly clear.

Let’s just thank goodness this is a finance test and not organic chemistry.

Grace Concelman is a senior majoring in finance and philosophy. She can be reached at [email protected]

The views expressed in this column are those of the author and not necessarily those of The Observer.