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Long-term Goals and Monetary Policy Strategy
The statutory role of FOMC is to foster maximum employment, price stability, and reasonable long-term interest rates. In executing this mandate, it is necessary for the committee to articulate its monetary policy plans to the general public for various reasons. First, communicating monetary policy decisions to the public helps households and businesses to make informed economic decisions in the future. Second, this action helps to decrease economic and financial uncertainty in the country. Third, it enhances the effectiveness of monetary policy by aligning the expectations of households and businesses to the plans of the FOMC. Lastly, articulating monetary policy decisions to the public promotes transparency and accountability which are the cornerstones of a democratic society.
The rate of inflation, unemployment, and long-run interest rates fluctuate over time under the influence of the prevailing economic and financial conditions. The effect of monetary policy decisions on the price levels and the level of economic activity is influenced by several forms of lags: time, information, and impact lags.
Time Lag. Time lag refers to the period between a moment when a monetary policy action is taken and the time when its effects are observed. Thus, the effect of monetary policy is not immediate, which means that all monetary policy action has to be future-oriented.
Information Lag. Information lag represents the time difference between the moment when the effect of monetary policy occurs and when the FOMC gets the official data about the impact so that it can be acted upon. There is considerable time involved in collecting and processing economic data, which explains the existence of the information lag.
Impact Lag. Impact lag, on the other hand, refers to the time difference between the moment when the effect of a monetary policy action is observed and when the FOMC can take action to change the course of the monetary policy. Sometimes the impact of a monetary policy is not the intended one which calls for the Fed to change the monetary policy. Reversing the impact of the original monetary policy usually takes time, explaining the existence of the impact lag.
The long-term rate of inflation is determined by the monetary policy. Therefore, the FOMC has the capacity of setting a long-term inflation rate. The committee’s target is two percent annual inflation based on personal consumption expenditures price index. The committee often conveys its planned inflation rate to the general public, with the aim of shaping inflation expectations in this domain, enhance price stability, and achieve medium long-run interest rates. Such communication also increases the rate of employment during volatile economic conditions.
The level of employment in the economy depends mostly on non-monetary factors relating to the structure and forces in the labor market. These factors are subjected to fluctuations and cannot be measured directly. Therefore, it is difficult for the FOMC to set an employment rate goal for the economy. The committee’s policies with regard to national employment revolve around determining the maximum level of employment. There are various indicators used by FOMC to measure the level of employment in the economy. Data on unemployment and rate of output for the economy is released quarterly by the committee.
Trade-off between Employment and the Rate of Inflation
Generally, the level of employment is inversely related to the rate of inflation. In making monetary policy decisions, FOMC tries to reduce the gap between actual and targeted inflation rates as well as the deviation of employment rate from the maximum level as established by the committee. These two goals are usually complementary but sometimes the committee has to balance the two objectives in case of conflict between them.
US Economic Situation
As of January 24, 2012 the US economic figures indicated that the economy was expanding at a low rate while the rest of the global economy seemed to be declining. The situation in the labor market had improved with the rate of national unemployment falling to 8.5 percent during December 2011. Despite this decline, the rate of long-term unemployment and part-time labor remained substantially high. The consumer price inflation remained low as well as long-term inflation expectations. Throughout the economy there were strong indications of growth in the last quarter of 2011. Data showed that firms increased their hiring rates during this period while insurance claims for unemployment insurance were on a downward trend.