Monetary Policy & Recession Meghan Shain AP Macroeconomics period 3 2/28/07 It is not only the decisions of the government that affect the economy. The Federal Reserve plays a major role in fixing perceived problems of economy. In the last few years, the Federal Reserve was concerned that the United States could experience rising inflation in the near future. Their goal was to prevent sudden, dramatically rising prices by raising interest rates a small portion at a time. This would protect the dollar from devaluing. Therefore, the Federal Reserve increased the federal funds rate a quarter percentage in 2005, up to 3.25 %. This would theoretically work because if banks have to pay higher interest on money that they borrow from other banks, they will charge higher interest rates on loans to their own clients, to compensate for the greater loss that they take in paying the interest to another bank. If interest rates are higher, then bank clients will not borrow money as much. This would decrease the money supply, and the amount of consumption, which was the overall goal of the Federal Reserve at the time, when they were very concerned with inflation. However, many economists were concerned that this would lead to a recession. This could occur because decreasing the money supply decreases aggregate demand and real GDP. Primarily, economists were concerned that this potential recession would destroy the housing market. They reasoned that if investment and business spending was too tight, then it would lead to a financial crisis, as the current housing slump would grow worse. Nationwide Median Price of an Existing Home $218,000 $216,000 $214,000 price $212,000 Series1 $210,000 $208,000 $206,000 2006 Jan-07 year visual 1: The author explains how decreasing home values can impact the economy as a whole. When the value of peoples’ homes goes down, they try to spend less to conserve. If people are spending less, then money is not being put into the economy. Economists acknowledge that this chain of events is possible, but have statistics that show that Americans are still spending enough to keep the economy going. They have placed a one in five chance of the country going into a recession, which most consider surprising, given that measures were previously taken to fight inflation. This article from MSNBC Business, “Many economists aren’t predicting a recession”, may be agreed with as true. This is because the logic is very thorough and sound. In addition, it addresses all aspects of the problem, going back to its origin several years ago. Most importantly, though, the author uses statistics to back up every statement . There is perhaps a little economic bias, however. The Federal Reserve wants to keep the consumer calm, to encourage them to trust in the money system and continue to spend money. Therefore, they are not very likely to be announcing that the economy is doomed to a horrible recession, because then everyone would rush to withdraw money from the bank, which would lead to a financial crisis. So there is some motivation to placate the consumer by telling them that there is no danger. The only logical fallacy is perhaps better called an ambiguity. A reason given for the low probability for recession is that “consumers have been spending sufficiently”, but this is not quantified. The author never gives the threshold between spending sufficiently or insufficiently. Therefore, the reader cannot tell how close the country is to a recession, and therefore there is a hole in the overall logic of the article, which does not disprove the conclusions, however.. word count: 560 Reference MSNBC Associated Press, 27 February 2007, Many economists aren’t predicting a recession, MSNBC Business, http://www.msnbc.msn.com/id/17369494.