By keeping its eye on
inflation
and the threat
of
recession,
the Fed can reduce the potential for disruption
in the U.S. economy that can result from either of these factors
spiraling out of control.
Of course, there are other forces affecting
the economy. The Fed can anticipate some of them in time to react,
and so keep the economy on an even keel. A scheduled tax cut is
a good example.
Other forces can’t be anticipated. There
are unexpected events, such as the oil embargoes of the early
1970s or the terrorist attacks of September 11. And, of course,
the economy is always subject to shifting public sentiment. People
overreact and underreact in ways that neither the Fed — nor
economists — can predict. The business climate may sour.
Consumer confidence may collapse. Or investors may experience
a surge of exuberance, rational or otherwise. In these instances,
a quick reaction from the Fed can reduce, but not eliminate, the
impact on the economy.
Anthony Santomero,
Federal Reserve
Bank of Philadelphia
Anthony Santomero of the Federal Reserve Bank of Philadelphia clarifies the limitations of monetary policy.
Monetary policy can’t eliminate the business cycle entirely. What we can do is mute the impact of large and persistent negative shocks to the economy. Think of it this way: Monetary policy is a powerful tool. But it is a blunt instrument. We can’t use it with surgical precision.
Anthony Santomero, 