Saturday, November 13, 2010

5 Myths about the Federal Reserve...The first one is very instructive for Monetary Policy in AP Macroeconomics

Five myths about the Federal Reserve

1. By printing money, the Fed will create runaway inflation.
The Nobel Prize-winning economist Milton Friedman issued a famous dictum nearly 50 years ago: "Inflation is always and everywhere a monetary phenomenon." His belief has become widespread over the years, to the point that even many non-economists assume that when the Fed prints money, higher prices inevitably result. But the link between money and inflation is weaker than people think. 
The Fed's current policy of "quantitative easing" essentially means it is printing money ($600 billion) to buy assets such as government bonds. The Fed isn't literally printing the $20 bills that end up in your wallet - it's doing the electronic equivalent. When it buys a $100 bond from a bank, it deposits $100 into the bank's account at the Fed. This electronic money is called reserves, and the Fed conjures it up out of thin air.

However, this money can lead to inflation only if banks lend it and consumers and businesses spend it. Banks lend when they have strong balance sheets and when credit-worthy customers demand loans. People and businesses spend when their incomes are growing and they're confident about the future. None of this has been true lately.
The Fed is trying to stimulate spending, but not by showering people with newly minted dollars. Rather, when the Fed buys bonds, it pushes their prices up and their yields down. Lower long-term interest rates will tempt some people to borrow. They will also make stocks more attractive. Higher stock prices will make consumers feel wealthier and spend more. If that spending outstrips the economy's productive capacity, inflation could result. But that's years away: The economy today is awash in idle factories and unemployed workers...(Click HERE to read the rest)
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