Preventing a Recession: The Fed Tries to Stave Off Disaster

Some of you following the news may have heard all the talk about the Fed, or Federal Reserve Bank, cutting rates as well as the proposed stimulus package that President Bush is attempting to get through Congress. We’ll cover these topics later in the semester, so you may want to pay attention to these stories when you see them and hear them on the news.

Here's a good article that talks about what the Fed is trying to do and what it’s historically done. Ben Bernanke, the subject of the article, is the Chairman of the Federal Reserve Bank, one of those bureaucracies we talked about in the first class. He replaced Alan Greenspan who retired last year.

FYI, Fed action falls into a category known as "monetary policy", that is policy that seeks to control the supply of money through the cost of borrowing. The fed cuts interest rates, it's cheaper to borrow money for banks, banks can lower their rates for borrowers, and more businesses can borrow and do more business... thereby growing the economy, in theory. Or there are times when the Fed wants to do the opposite and actually contract the supply of money and increase the costs of borrowing so as to slow things down. Think of these as the gas pedal and the brakes. Both have uses.

Fiscal policy, on the other hand, falls into the realm of spending by the government. This includes actual spending as well as tax cuts or tax increases. Both can be used in efforts to brake the economy or to give the economy some gas. Since politicians want to be reelected, there aren't many instances where they deliberately hit the brakes on the economy, regardless of the need... such as inflation, which we'll get to later...