December 5, 2016 Prediction of FED Action: Going Up

Authors: Emma Conrad & Sarah Todoroff

Editor: Miles Mortali

            Walking into the highly secure gold vault in New York City’s Federal Reserve brings a sheer feeling of shock and disbelief. One is suddenly surrounded by approximately US $250 billion worth of gold. Thousands of tons of gold bars sit in two rooms on a foundation of bedrock, deep below the hustle and bustle of the City. The sheer weight of the gold is why it is housed in the Big Apple, since New York City’s unique bedrock allows very heavy structures to be built without the worry of collapse. However, only 2-3% of the gold in the vault belongs to the U.S. government. This is not enough gold to back the United States currency currently in circulation. This, among other reasons, is why Janet Yellen believes, contrary to President-elect Donald Trump’s opinion, that we should not revert to the gold standard (Davidson 1). This is just one of many fiscal policies that the two disagree on, and is why many think that Trump will not re-appoint Yellen as the chair of the Board of Governors at the end of her term.

            When considering President-Elect Trump’s policies and the current state of the economy, our prediction is that the Board of Governors will raise rates from 0.25% to around 1% on December 14th. Before 2007, the federal funds rate rose to 5.25% in June 2006. However this was just the calm before the storm as the housing market crashed in 2007 and the recession followed in 2008. In response, the Federal Reserve steadily reduced the interest rate to combat high unemployment and low inflation. It appears, the plan (when combined with the then-affect fiscal policy) has worked so far, as unemployment is now below the natural rate at 4.96%  and inflation is at 1.6%. Now as the economy is back on the rise, the Board of Governors it may now be the time to change policy- increase rates, especially given anticipated fiscal policy changes of a Trump administration.

            Many economic and political factors will affect the upcoming decision by the Federal Reserve. One of which being the fact that many states recently raised their minimum wages. Due to the unemployment rate being under the natural rate of unemployment, employers are not hiring new workers but are forced to pay their employees more due to the mandated raise in wages, which pressures the prices of commodities to inflate. This increases the cost of hiring for job creators. This recent event also backs up Ms. Yellen’s decision to raise the rate because if the wage goes up, more people will be inclined to look for jobs which will hopefully increase the labor participation rates. Unemployment, notwithstanding a rise in minimum wage, could go down, even more, putting it much lower than the natural rate and raising inflation. Another factor leading to the decision to raise the rates is the recent election of Donald Trump. The President-elect’s economic policies appear to focus on cutting taxes and investing 1 trillion dollars on repairing and updating infrastructure in the United States. This economic plan is expected to provide more jobs, while raising inflation rates. We expect The Fed to take preemptive action by raising the federal funds rate so if Trump’s plan does raise inflation, it will not launch us into another economic crisis by shocking the system.

            According to the Federal Reserve, the changes they implement will take up to two years to affect the economy. This coincides with the likely time limit it will take for Trump’s economic plans to come to action. If the rate should increase as we are predicting, the dollar’s value will rise. This will strengthen the attraction of bonds and treasuries to foreign investors which will raise the demand for the dollar, allowing it to appreciate in value. A higher rate will also make the stock market more competitive, allowing people to invest more in long term bonds. This will also have an effect on lending money versus saving money. Because the fed funds rate will increase the rate banks can lend money to each other, acquiring loans will become difficult. However, consumers with large savings accounts will receive higher interest payments. With the value of the dollar increasing, exports would be expected to fall as imports would be expected to rise, assuming President Trump does not impose tariffs on imported goods. Most foreign consumer’s demand for U.S. products is relatively inelastic, therefore, if the dollar value rises, the U.S. will make more revenue on these products.

            Overall, with the federal funds rate being stagnant for so long, the Board of Governors thinks we are ready for a change. The economy is now strong enough to withstand an increase in the interest rate, since our bounce back from the 2008 Recession. We are now more prepared than ever to push through whatever may happen in the next four years. However, “Yellen also said Trump’s victory has not altered Fed plans to raise interest rates next month, though his economic policies eventually could force the central bank to reassess its outlook.” This should be an indication to all that no matter who is in the office for the next four years, the economy is strong enough to handle some change.



Additional Sources:

(Emma Conrad attended a tour of the Federal Reserve in New York City and made mental notes of the tour guide’s facts. These facts were implemented into the first paragraph.)

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