The Federal Open Market Committee (FOMC) of the Federal Reserve System cut the interest rates by ?% in order to have a stimulating effect on the US economy. The following essay will uncover the Feds motives in a question answer form. In the language of your textbook, is the discussion related mostly to aggregate demand or aggregate supply weaknesses? It is apparent that because the main issue was slugging consumer spending (which constitutes a larger part of the GDP), the weakness can be attributed to the short-term aggregate demand. Should the consumer spending remain extremely low for at least 6 months or more, the short-term aggregate demand weakness would have a drastic influence on the long-term aggregate supply, that in turn would shrink to meet the lower demand. The weakness of the aggregate demand as is seen from the FOMC minutes has an immediate negative impact on the GDP. The Committee indicates that consumer spending (C) has held up “reasonably well thus far,” but expresses reasons why this trend may not continue.
What important negatives does the Committee see ahead for consumption expenditures? Simply because consumers influence the aggregate demand and supply interaction their spending role is extremely important. Unless the interest rates are cut again to de-motivate the consumers to save but rather encourage them to spend, the industries might see the decline in profits across the country. Another reason why the consumer spending might drop is because of the increase in unemployment that will make more people save every penny for the rainy day rather than to spend it in a usual manner. What does the Committee expect for private business investment over the coming months? Why? FOMC expects to have the private business investment increase over the several upcoming months. The current date indicated that although private business investment on computers and software certainly boosts productivity, the risk-aversion of Americans holds business investment lower than expected by FOMC. Therefore, the committee expects to witness increased private business investment mainly because of the balanced monetary and fiscal policies, which makes it either less risky or more lucrative to invest in business.
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As a consequence, a slowly improving outlook for sales and profits, low financing costs, and the temporary federal tax incentive for investment in new equipment and software were expected to boost business investment spending (http://www.federalreserve.gov/fomc/minutes/200211 06.htm).
Homebuilding activity also is a part of private investment expenditure (I).
What does the Committee expect for homebuilding activity over coming months? Why? With the interest rates being historically low (and further ?% decrease ) house building activity is expected to raise mainly because it becomes cheaper than every to borrow money from the bank to build a house. Furthermore, with the interest rates being historically low, Home building activity presents an alternative investment opportunity for those who are not willing to invest money in the banks at the prevailing rates. How is the weakness in foreign economies likely to affect the demand for U.S. goods? If foreign economies get weaker, the demand for all goods (including exported US goods) will decline, thus negatively impacting the US exporters to these foreign countries. Furthermore, if the foreign economies get weaker, their currencies are more likely to depreciate against the US dollar making the US goods less competitive by price.
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As a result, the foreign demand for the US goods will also decline. In light of the discussion summarized by the above questions and answers, according to the Committee, in what direction are risks weighted in the foreseeable future? According to the FOMC minutes the risks are tilted towards economic weakness in the foreseeable future. The interest cut is expected to give a little economic boost to the US economy in the long run, and as the members of the FOMC said they would still expect the US economy under-perform in the nearest future. The fact that the interest rates were cut by ?% rather than ?% indicates the desire of the committee to have the least possible intrusion in the market stimulating additional consumer spending, and risk taking.
Bibliography:
http://www.federalreserve.gov/fomc/minutes/2002110 6.htm.
