Answer to Question #158319 in Macroeconomics for Meer Hamza Lund

Question

Q7. Fed Sees Unemployment and Inflation Rising It is May 2008 and the Fed is confronted with a rising unemployment rate and rising inflation. Source: CNN, May, 21, 2008

   a. Explain the dilemma faced by the Fed in May 2008.

   b. Why might the Fed decide to cut the interest rate in the months after May 2008?

   c. Why might the Fed have decided to raise the interest rate in the months after May    2008?

Answer 1

Dilemma faced by Fed in may 2008

High prices of oil blinded Fed to danger before the crash. it was after Lehman failed and Fed was deciding what to do. It was fighting credit crunch for the whole year, and the worst scenario was out. A great bank failed, and the rest financial system was ready to get knocked. Fed never had much room to cut interest, however it still should have. The risk was greater. Fed chair, Bernanke called financial accelerator a weak financial system and economy making others weaker. Fed was blinded. it was when high oil prices begun distracting it from financial crisis. The economy was teetering, oil prices were skyrocketing and financial system was paralyzed.

Why might the Fed decide to cut the interest rate in the months after May 2008?

Uncertainty across the worldwide growth as well as persistently low inflation tend to be the reason why Fed may decide to cut interest rates, since they pose a big threat to the economy's health at the time when central bank has limited ammunition of fighting off a downturn.

Why might the Fed have decided to raise the interest rate in the months after May   2008?

Due to the financial crisis and economic contraction intensifying the fall of 2008, Fed may have decided to raise interest rates, taking it to its effectual floor. Similarly, Fed may consider raising interest rates due to too much growth. Rate increases are utilized in slowing inflation and returning growth to more sustainable levels.