What is monetary policy?
Monetary policy is one of two tools the government uses to control the economy. Fiscal policy is the other tool. The government uses fiscal policy to change revenue collection (taxation) and expenditure (spending) in order to influence the economy. Through the process of monetary policy, the authority of the country (the Federal Reserve, in the case of the U.S.) controls money supply by targeting interest rates in order to maintain price stability and promote high economic growth.
The monetary policy report submitted to Congress on February 11, 2014
As per the recent monetary policy report, the outlook for the U.S. economy remained positive. The objective of the Fed’s monetary policy is to support continued progress toward maximum employment and price stability. As per the Fed, the labor market has improved in the second half of 2013 and into early 2014. The unemployment rate had declined from 7.5% in June 2013 to 6.6 % in January 2014 before the FOMC began its first taper. Even with these improvements, the unemployment rate remains well above levels FOMC participants judge to be sustainable in the longer run.
Also, consumer price inflation has remained low. The price index for personal consumption expenditures rose at an annual rate of only 1% in the second half of the last year, noticeably below the FOMC’s longer-run objective of 2%. However, the softness in the inflation rate is predicted to remain for a short time. Lacker stated that he’s “pretty confident inflation is going to trend back towards 2% this year.” Real gross domestic product is estimated to have increased at an annual rate of 3.75%, up from a 1.75% gain in the first half of 2013.
Lacker’s take on monetary policy
In his speech, Lacker reiterated his opinion on the country’s monetary policy, saying monetary policy should focus on the Fed’s dual mandate of keeping inflation low and stable. Lacker had dissented to the Fed’s attempt to combine monetary policy with financial market stability, saying, “Deflecting monetary policy from its price stability mission to make up for some market imperfections—or misconstrued government policies that are driving some sector away from where it should be—seems to be misguided. I think we should conduct monetary policy as we always have when we’ve been successful, with our eye on the objective of keeping inflation low and stable.”
Lacker also emphasized the volatility in emerging markets—particularly the tension in Ukraine—and said he will be watching the situation carefully to assess the impact on U.S. economic growth and commodity markets. Other things remaining constant, if conditions in Ukraine continue to worsen, we may see investors pulling back from emerging market tradable equivalents such as the iShares MSCI Emerging Markets (EEM) and particularly the VanEck Vectors Russia Small-cap ETF Trust (RSX). RSX’s top ten holdings include two major Russian oil and gas producers, LUKOIL (LUKOY) and Gazprom (OGZPY), both of which may experience volatility with rises in Ukrainian-Russian tensions. This may benefit U.S. Treasury bond ETFs such as the iShares 20+ Year Treasury bond (TLT), as investors will look forward to parking their cash into safer markets.
To learn more about why Lacker is closely watching the Ukraine, read on to the next part of this series.