Federal Reserve

Federal Reserve Paper
Kathy Routson Jones
Dr. Shari Lyman
April 19, 2010
Money is anything generally accepted as payment for goods and services and repayment of debts. For example, money functions as a medium of exchange, a unit of account, a standard of deferred payment, and a store of value. However, most modern textbooks list only three functions, medium of exchange, unit of account, and store of value, not considering a standard of deferred payment as a distinguished function, but rather consider it in the others.
The Federal Reserve (Fed) or Central Bank has two tools. It can change the interest rates on the money it lends to banks. A higher interest rate makes money more expensive, thus discouraging banks to lend. Lowering interest rates causes the opposite effect. The second tool the Fed has is the power to change reserve requirements. A reserve requirement is the percentage banks must keep in their vaults of their total loan portfolio. Obviously, if the Fed lowers this requirement, the banks can increase their leverage and lend out more.
Projections for real GDP growth in 2010 had a central tendency of 2.8% to 3.5%, a somewhat narrower interval than in November. Recent readings on consumer spending, industrial production and business outlays on equipment and software were seen as broadly consistent with the view that economic recovery was underway, although at a moderate pace. Businesses had apparently made progress in bringing their inventory stocks into closer alignment with sales and hence would be likely to raise production as spending gained further momentum. Participants pointed to a number of factors that would support the continued expansion of economic activity, including accommodative monetary policy, ongoing improvements in the conditions of financial markets and institutions, and a pickup in global economic growth, especially in emerging market economies. Several participants also noted that fiscal policy was currently providing substantial support to real activity, but said that they expected less impetus to GDP growth from this factor later in the year. Many participants indicated that the expansion was likely to be restrained not only by firms caution in hiring and spending in light of the considerable uncertainty regarding the economic outlook and general business conditions, but also by limited access to credit by small businesses and consumers dependent on bank-intermediated finance.
Economists projections were for GDP growth to pick up in 2011 and 2012; the projections for growth in both years had a central tendency of about 3.5% to 4.5%. As in November, participants generally expected that the continued repair of household balance sheets and gradual improvements in credit availability would bolster consumer spending. Responding to an improved sales outlook and readier access to bank credit, businesses were likely to increase production to rebuild their inventory stocks and increase their outlays on equipment and software. Improved foreign economic conditions are viewed as supporting robust growth in U.S. exports. It is also indicated that elevated uncertainty by households and businesses and the very slow recovery of labor markets would likely restrain the pace of expansion. Although conditions in the banking system appear to have stabilized, distress in commercial real estate markets is expected to pose risks to the balance sheets of banking institutions for some time, thereby contributing to only gradual easing of credit conditions for many households and smaller firms. In the absence of further shocks, participants generally anticipated that real GDP growth would converge over time to an annual rate of 2.5% to 2.8%, the longer-run pace that appeared to be sustainable in view of expected demographic trends and improvements in labor productivity.
Participants anticipated that labor market conditions would improve only slowly over the next several years. Their projections for the average unemployment rate in the fourth quarter of 2010 had a central tendency of 9.5% to 9.7% only a little below the levels of about 10% that prevailed late last year. Consistent with their outlook for moderate output growth, participants generally expected that the unemployment rate would decline only about 2-1/2% points by the end of 2012 and would still be well above its longer-run sustainable rate. Some participants also noted that considerable uncertainty surrounded their estimates of the productive potential of the economy and the sustainable rate of employment, owing partly to substantial ongoing structural adjustments in product and labor markets. Nonetheless, participants longer-run unemployment projections had a central tendency of 5.0% to 5.2%, the same as in November.
Most economist anticipate inflation will remain subdued over the next several years. The central tendency of their projections for personal consumption expenditures (PCE) inflation was 1.4% to 1.7% for 2010, 1.1% to 2.0% for 2011, and 1.3% to 2.0% for 2012. Many participants anticipated that global economic growth would spur increases in energy prices, and that headline PCE inflation would run slightly above core PCE inflation over the next year or two. Most expected that substantial resource slack would continue to restrain cost pressures, but that inflation would rise gradually toward their individual assessments of the measured rate of inflation judged to be most consistent with the Federal Reserves dual mandate. As in November, the central tendency of projections of the longer-run inflation rate was 1.7% to 2.0%. A majority of participants anticipated that inflation in 2012 would still be below their assessments of the mandate-consistent inflation rate, but the remainder expected that inflation would be at or slightly above its longer-run value by that time.

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