Explain the difference between M1 and M2 money supply
Explain the role of banks
Understand the functions of the Federal Reserve System
Understand what the Federal Reserve System does to carry out monetary policy
The Fed and Economic Stability
This Apply It continues using the doom spending case study video from earlier in this module. The video is included below in case you want to refresh your memory about specific details, but if you have already watched it, you don’t need to watch it again.
Remember that the video discussed how tariff uncertainties have affected consumer confidence, with many Americans spending more to avoid future price increases. The video also mentioned the Federal Reserve’s hesitation to adjust interest rates due to unclear economic signals.
The video mentions the Federal Reserve decided to “wait and see” and leave interest rates at their current level. How does this reflect the Fed’s dual mission of maintaining price stability and maximum employment?
In this economic environment of uncertainty caused by tariffs and changing consumer behavior, the Fed faces a dilemma. On one hand, rising inflation concerns and “doom spending,” might typically call for higher interest rates to curb inflation and preserve price stability. Higher rates would make borrowing more expensive, potentially cooling excessive spending and stabilizing prices.
On the other hand, with concerns about a possible economic downturn, consumer confidence at a 12-year low, and experts cautioning that reduced spending could trigger a recession, raising interest rates in this scenario could excessively restrict economic activity. This could potentially increase unemployment which goes directly against the Fed’s goal of maximizing employment.
By adopting a “wait and see” approach, the Federal Reserve is carefully monitoring both sides of its mandate before acting. This demonstrates how the Fed must carefully weigh conflicting economic indicators to determine which aspect of its dual mandate faces the greater risk before implementing monetary policy decisions. This cautious approach reflects the Fed’s responsibility to maintain long-term economic stability rather than reacting to short-term economic fluctuations.