The three most important things I learned in Economics Class
The first important concept I learned was the ‘goals of monetary policy’. The primary goal of a central bank is price stability (low and stable inflation). Some of the Feds (short for the Federal Reserve Bank) other concerns are:
• high employment
• economic growth
• stability of financial markets
• interest rate stability
• stability in foreign exchange markets
The Fed desires to maintain high employment because the condition of high unemployment, the alternative, creates idle workers and idle resources. This leads to closed factories, unused equipment and materials, ultimately decreasing our GDP. Now, let me further explain that the goal for high unemployment is not an unemployment level of zero, rather a level above zero where labor demand equals labor supply. This is known as the ‘natural rate of unemployment’.
Economic growth focuses on encouraging firms to invest or encouraging people to save, which in turn creates funds for firms to invest. It runs hand-in-hand with the goal of high employment because in order for firms to be comfortable investing in assets such as plants and equipment, unemployment must be low. Hereby, the people and resources will be available to spur economic growth.
If financial markets are instable, it will lead to sharp contraction of economic activity. For example, in this most recent financial crisis, a deterioration in financial institutions’ balance sheets, along with asset price decline and interest rate hikes increased market uncertainty thus, worsening what is called ‘adverse selection and moral hazard’. This is a serious dilemma created before business transactions occur which information is misleading and promotes doing business with the ‘most undesirable’ clients by a financial institution. In turn, these ‘most undesirable’ clients later engage in undesirable behavior. All of this leads to a decline in economic activity, more adverse selection and moral hazards, a banking crisis and further declining in economic activity. Ultimately, the banking crisis came and unanticipated price level increases and even further declines in economic activity.
Interest-rate stability is very important for the Fed to control because otherwise consumers, like you and I, will be reluctant to buy things like houses due to the fluctuation which will make it harder to plan for the future.
The value of the US dollar relevant to other currencies is a major consideration for the Federal Reserve. If they prevent large changes in the value of the dollar, firms and individuals can comfortably plan ahead to purchase or sell goods abroad.