Question

Suppose you are a member of the FOMC and the U.S. economy is entering a recession. Write a directive to the New York Fed about the conduct of monetary policy over the next two months. Your directive should address a target for the rate of growth of the \(\mathrm{M}_{2}\) money supply, the federal funds rate, the rate of inflation, and the foreign exchange value of the dollar versus the Japanese yen and curo. You may refer to the Board of Governors website, www.federalreserve.gov/monetarypolicy, for examples, since this site posts FOMC directives.

Short answer

Answer: In a hypothetical recession scenario, the main objectives of monetary policy should be to stabilize the economy and foster growth by stimulating spending, production, and aiding the labor market. The appropriate targets are as follows: 1. Rate of growth of the M2 money supply: 4.0% to 6.0% 2. Federal funds rate: 0.25% - 0.75% 3. Rate of inflation: 2.0% to 3.0% 4. Foreign exchange value of the dollar: Depreciation of the U.S. dollar against major currencies like the Japanese yen and the euro by approximately 3% to 5%.

Step-by-step solution

1. Introduction and main goals

We are facing a recession, and the main objectives must be to stabilize the economy and foster growth. Therefore, the monetary policy should target the rate of growth of the M2 money supply, the federal funds rate, the rate of inflation, and the foreign exchange value of the dollar, in order to stimulate spending and production, aid the labor market, and decrease strain on the economy.

2. Target for the rate of growth of the M2 money supply

During a recession, the main goal is to increase the money supply to stimulate economic growth. Therefore, the FOMC should pursue an expansionary monetary policy and aim to increase the M2 money supply at a rate of 4.0% to 6.0% over the next two months.

3. Target for the Federal funds rate

In order to encourage borrowing and investment during this recession, we should decrease the Federal funds rate. The FOMC should target a decrease in the Federal funds rate to 0.25% - 0.75%.

4. Target for the rate of inflation

Higher inflation can lead to increased spending, which can drive economic growth. Our target should be to aim for an increase in the inflation rate to around 2.0% to 3.0%.

5. Target for the foreign exchange value

A weaker dollar can stimulate exports and reduce imports, which can support domestic production and economic growth during a recession. We should aim for a gradual depreciation of the U.S. dollar against major currencies like the Japanese yen and the euro. A specific change in exchange rates is difficult to prescribe, but decreasing by approximately 3% to 5% could help boost exports and contribute towards economic recovery.

6. Conclusion and implementation

To counter the recession, the FOMC should adopt an expansionary monetary policy targeting the rate of growth of the M2 money supply, the federal funds rate, the rate of inflation, and the foreign exchange value of the dollar against major currencies. Employing these measures could help and stimulate consumption and investment, stabilize labor markets, and support economic growth during the recession. The New York Fed should implement these measures over the course of the next two months while closely monitoring the economy.