Monetary Policy and Gdp Research Paper

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U.S. Economic Assessment

economy has been relatively stable for the past few years, with unemployment being slowly reduced, GDP growth slow but stable, low interest rates for many years and inflation being largely held in check. Short run fluctuations have been just that -- short run events that do not seem to have impacted long-run economic policy nor the long-run direction of the U.S. economy.

In basic macroeconomic theory, short run events should not have much significant impact on long-run economic outcomes. In the short run, if there is an increase in aggregate demand, that should reduce aggregate supply. The supply side will then increase production to meet the higher demand level. If the demand spike was short-lived, this will result in an overproduction, and production will then need to be reduced again to work down this oversupply. If aggregate demand has ended up back at its starting point, so too will aggregate supply. The disruption to the trend will be minor, and the trend restored in a matter of a few months, back to the normal equilibrium level (Investopedia, 2016).

If the short-run shift in aggregate demand holds over the long run, then production increase will also need to hold, increasing aggregate supply to meet AD at the new equilibrium point. This will reflect in macroeconomic figures as sustained growth.

The former type of fluctuation, where the change in AD is short-run, should not have long-run lasting impacts on the overall health of the economy. Inflation rates and unemployment are stickier than AD and even AS, so the response to a minor short-run change in AD should probably not amount to much in terms of long-run outcomes. Only when a change is either long-run in nature, or strong, should there be an expectation of long-run change in other macroeconomic outcomes. In particular, because short-run changes are unlikely to influence things like interest rates, trade agreements or large scale moves in major markets like housing, the impact should be muted, because minor short-run events do not trigger changes in the major drivers of long-run macroeconomic change.

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The U.S. economy is well-adapted to absorbing short-run changes in AD or AS.

CPI vs. GDP PI

The Consumer Price Index (CPI) is one of the main measures of inflation in the U.S. economy. The CPI is used by the Federal Reserve to help guide its monetary policy, and that lends the CPI a certain degree of influence. The Fed targets at CPI of 2% over the long run. If the CPI runs much higher or lower for a prolonged period, then the Fed is more likely to change interest rates. The Fed sees issues with both higher inflation and lower, and thus views 2% as sort of a magic number, and any sustained deviation from that number can be expected to trigger a shift in interest rates or other monetary policy lever (Federal Reserve, 2015).

The FOMC uses a personal consumption index for prices, which is CPI or core CPI, rather than the GDP price index. The GDP price index is more broad-based, including business, government and foreigner spending, as well as consumer spending (BLS, 2016). The reason that the FOMC looks at consumer spending alone is because the Fed views its mandate as being oriented towards American citizens and consumers -- it looks at inflation and unemployment through this lens in particular), on the theory that government and business spending will ultimately be reflected on consumer spending anyway. Thus, while GDP price index is more complex as a measure, it does not appear to play a direct role in FOMC decisions. GDP does, however, because the Fed wants to see healthy, sustained GDP growth, and will adjust monetary policy to encourage this. The Fed already tracks GDP, so in that sense it also wants to use the CPI as a means of adding a different perspective. The GDP and GDP price index….....

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