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2007 monetary policy of Bernanke

On March 28th, 2007 the Fed Chairman Bernanke delivered his monetary policy report to the Joint Economic Committee of the US Congress. In his remarks, he expressed his concern about the uncertainty of the recent decline of the real estate market and its possible negative spillover effects on consumption and investment in coming months. He also indicated that the real GDP growth rate will stay at a moderate rate of 2% over the rest of the year and inflation will continue to be rising at a steady pace of 2.7%. However, he also reiterated his previous position in keeping the federal fund rate at its present rate of 5.25%, which was not changed since last June 2006. His reason for not reducing the federal fund rate from its present target was due to the persistence of higher expected inflation. The full text of his remarks can be read in this url http://federalreserve.gov/boarddocs/press/monetary/2006/20060328/default.htm.

The primary objective of the Fed (led by Bernanke) is to keep a balance between higher expected inflation and interest rates and their impact on sustained economic growth in the long run.

In your opinion, briefly and critically describe possible short run and long run macroeconomic effects of this policy prescription by the Fed in controlling inflation and money supply growth in the economy. Your response to this question should be focused on the effects on unemployment, inflation, short term and long term yields on treasury securities, and economic growth. Is this policy consistent with the discretionary monetary policy implications of Keynesian monetary theory? If so, how does it differ from the policy prescription of the monetarists under the similar economic situation that US economy is currently facing? (Hint: Monetarists' view of monetary policy is to undertake the long term economic growth without any discretionary action in controlling money supply in the short run. Keynesian monetary policy is characterized by discretionary policy in controlling money supply as warranted by business cycle fluctuation).

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STEP 1
Effects on unemployment:
In the short run the unemployment level may increase because the high rate of 5.25% may hold back investment in business. However, in the long run unemployment will increase because a healthy growth rate is being maintained. In addition, unemployment will be reduced in the long run because of increase in real exports and an increase in high-tech equipment by 9 percent.

STEP 2
Inflation:
The federal fund rate of 5.25% will keep the inflation under control. This is true in the short run. However, if this rate is held for a long time and investment in business is limited because of the high federal fund rate there will be inflation in the long run. In the long run the production process will not be able to meet the demand and there will be too much money chasing too much ...

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