Predicting the direction the in which the
economy is headed and taking appropriate action before inflation
explodes or
recession
sets in is not an easy task.
That’s true in part because what’s
happening in the economy is reflected in the real rate of
growth,
which is the growth rate after inflation has been subtracted.
But the real rate is very hard to determine. For one thing, the
pace of inflation is not predictable. Traditional patterns don’t
always develop. Further, events, both expected and unexpected,
can have a dramatic impact on the economy or on inflation, or
both.
In addition, the Fed’s limited tools,
which have more-or-less predictable short-term consequences, have
no direct control over long-term developments. For example, open
market operations change the short-term interest rates, but they
do not determine mortgage or other long-term rates.
Further, the immediate response to an action
to tighten or loosen the money supply may be muted because everyone
expects it or because other factors the Fed can’t control
— such as weak corporate earnings or a tax increase —
are making a bigger impact on the economy.
And, while one side effect of loosening the
money supply and lowering interest rates is that investors are
often encouraged to invest more heavily in the stock market, that’s
an indirect response, and not a consequence the Fed can control.
