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The Fed expands and contracts the money supply to keep inflation around 2%. They use it as a tool to smooth out financial expansions and contractions by affecti
by polishninja 11y ago
The Fed expands and contracts the money supply to keep inflation around 2%. They use it as a tool to smooth out financial expansions and contractions by affecting interest rates which affect the demand for money vs interest bearing holdings.
Currently, they expanded the money supply past demand to accommodate the 2008 crisis and now we are caught in a liquidity trap. If the Fed now wants to stimulate the economy by lowering the interest rate though expanding the money supply they can't, because the interest rate is at the lower bound of 0%. They need to now use less effective and unconventional methods to affect the economy.
- dragonwriter 11y agoAs you note, monetary policy is largely a tool to "smooth out financial expansions and contractions"; that is, its a tool to tweak around the edges of fairly short-term normal cyclical fluctuations. It may be sufficient to adequately mitigate harmful disruptions from those kinds of normal cyclical fluctuations in the economy, but its not adequate for dealing with all economic issues. The more powerful tool for dealing with economic issues is fiscal policy, which is the domain of Congress, not the Fed. But Congress has largely failed to act, or acted counterproductively, for many years, and left the Fed and monetary policy to handle things that need Congress and fiscal policy to address. So, yes, the Fed's pretty much exhausted its tools, because its been forced to deal with a problem exclusively through monetary policy that should have been addressed through fiscal policy.