Imagine you are the policy advisor for the Federal Reserve during this time period. Comparing the graphs during the same windows of dates/years, explain at what point you would advise the Federal Reserve to act (3 points). Using specific information from the graph describe why you would advise them to action at that time (3 points). Give at least 2 steps the Federal reserve might take to regulate the US economy and the expected outcome (4 points). Chose only one time period to describe policy advice.

Question

*Note- Q1 is January-March of any given year, Q2 is April- June of any given year, Q3 is July- Sept of any given year, and Q4 is Oct- Dec of any given year. When answering, make sure you actually specify the year you are referring to.

REMINDER - Absolutely no outside resources are allowed to be used on tests. This includes but is not limited to the use of lessons, notes, internet resources, and artificial intelligence. To do so is a violation of the honor code and will be reported.

(10 points)

Answer 1

As a policy advisor to the Federal Reserve, I would advise action during Q1 of 2022.

1. Observation of Economic Indicators: In Q1 of 2022, I would notice a significant increase in inflation rates, surpassing the Federal Reserve's target of 2%. The Consumer Price Index (CPI) might show a year-over-year increase of over 7%, indicating that prices for goods and services are rising rapidly. Additionally, core inflation measures, which exclude volatile food and energy prices, would also show concerning growth, suggesting widespread inflationary pressures.

2. Labor Market Conditions: During this time period, the unemployment rate could be substantially low, near 3.5%. This low unemployment rate, coupled with rising wages, might lead to increased consumer spending and demand, further exacerbating inflationary pressures. The labor market appears strong, suggesting that the economy is operating above its potential, which can lead to overheating.

3. Supply Chain Issues: I would also take into account the ongoing supply chain disruptions that have persisted since the COVID-19 pandemic, which would be contributing factors to rising prices. If there are signs that these disruptions are not easing, it would signal a persistent inflation problem rather than a temporary spike.

Based on these observations, I would advise the Federal Reserve to take the following steps:

1. Raise Interest Rates: I would recommend increasing the federal funds rate by 0.25% to 0.50% at the next Federal Open Market Committee (FOMC) meeting. This would help to cool down inflation by making borrowing more expensive, thereby slowing consumer spending and investments.

2. Tapering Asset Purchases: I would also advise the Federal Reserve to begin tapering its asset purchase program. By reducing the amount of treasury and mortgage-backed securities it buys each month, the Fed would decrease its balance sheet and help to tighten monetary policy more broadly.

Expected Outcomes:

• By raising interest rates, we would anticipate a slowdown in borrowing and spending, which could alleviate some inflationary pressures over time. This could lead to a stabilization of prices and potentially bring inflation back down toward the target level.
• Tapering asset purchases would signal to the markets that the Fed is taking inflation seriously, which could help strengthen the credibility of the Fed’s commitment to controlling inflation. This action could also lead to a gradual increase in long-term interest rates, which could further moderate economic activity in an overheated economy.

In conclusion, advising action in Q1 2022 based on rising inflation, a low unemployment rate, and ongoing supply chain issues would help the Federal Reserve navigate the challenges posed by an overheating economy effectively.