Outline and critically appraise the justifications for the current US monetary policy of very low official interest rates, and the likely consequences of that policy.
In times of Financial Crisis, where markets fail to deliver solutions, it is expected that government intervention in the form of monetary and fiscal stimulus will be utilised as a solution. However, given the severity of the current crisis policymakers face tough new economic challenges that are reminiscent of the 1930's Great Depression. One particular form of stimulus has come from the US Federal Reserve's decision to maintain low interest rates. This paper aims to analyse the justifications for such low interest rates and discuss the likely consequences of such a policy stance.
With the onset of the Global Financial Crisis (GFC) in 2007, the US Federal Reserve (the Fed) has shifted towards a policy of monetary easing in an attempt to quash fears of a prolonged recession.
English: Detail from Government. Mural by Elihu Ve...
Former Chairman of the Federal Reserve Alan Greens...
Alan Greenspan, former chairman of the Board of Go...Since September 2007 , official rates have fallen from 5.25% to 0.25% in December 2008 (TradingEconomics.com, 2009), with a clear pledge to keep rates low for as long as necessary (FOMC, 2009).
In recent history, US monetary policy has been focused (but not exclusive) on maintaining a target inflation rate of 1-2% over the course of a business cycle (Bernanke, 2003). Low interest rates would imply inflationary pressure due to increased demand for money. However, the Fed has justified the low rates as necessary to fight the recession, given the fact that the alternate monetary policy objectives, of employment and economic growth, are of greater concern than inflation in the current climate (Lonski, 2008). These lower rates will help increase the supply of credit to the private sector, and tend to widen net interest margins for financial intermediaries. While wider margins are not necessarily the desired...