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Monetary policy and Inflation

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  1. Introduction.
  2. Statement.
  3. Discussion.
    1. The monetary policy of an economy.
    2. Balancing the monetary flow of the economy.
    3. Williamson (2005) economic and policy models.
    4. The catalytic events that followed the announcement of the new economic policy.
  4. Conclusion.

The US economy has always seen turbulent cyclical effects of inflation and deflation. To gauge the balance between the two experts at the Federal Reserve has always adopted the traditional macroeconomic tool of monetary and fiscal policies. These policies depending on the nature of the situation have helped the country survive some of the toughest economic crises in the American economic history. To name a few, the Great Depression, Inflation of the 1980s stock crash as well as the tech bubble burst during the 1990s. These events have become the cornerstone and a signal for Federal Reserve experts to beware of the coming deflationary or inflationary turn. In the recent years after the crash of the September 11 events, the country once again had seen an economic downfall with many companies going bankrupt while others are forcefully closed due to deteriorating corporate governance. These changing and dynamic economic environments have had great adverse effects on the economy. For this reason the Federal Reserve chief Alan Greenspan and his counterparts have been involved in balancing the economy albeit unsuccessfully.

[...] When there is moderate inflation there is little that the monetary policy can do with drastic measures such as changing the interest rate and implementing open market operations. This is because these measures are long term or rather moderately short term. An announcement of increasing or tightening the economy would bound to create hikes in prices and thereby increase the speed of inflation. This observation is inherent in the recent Testimony to Chairman Greenspan (2005). At the time of the issuance of the policy evidence suggest that economic fundamentals have sustained consumer spendings and increased personal income through net worth gains and credit markets. [...]


[...] The objective of a monetary policy is to keep inflation low and other factors such as consumption, employment and investments high. This is because when interests are low, businesses flourish, there is more employment and when people have more savings they invest more and the cycle goes on. On the other hand when there is a high inflation prices are high, consumption as a result is low, there is little business and profitability to keep the flow of money in the economy to sustain the investment. [...]


[...] However, as opposed to this improvement scenario the Testimony also provided the view that inflation developed and influenced the exchange value of the dollar and oil prices. The culprit has impacted the economy and as a result measures must be taken to counteract the emerging financial crisis. The above observations indicate that there had been no need for the dire measures of curbing interest rates which merely created confusion in the economy. Cooper and Madigan (2005) observe a rising cost pressure on the business community. [...]

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