Fed Puzzle

   Yesterday we mentioned the puzzle the Federal Reserve Board faces in trying to meet its twin goals of encouraging full employment and minimizing inflation.
   There is no direct way of working toward these goals. The Fed can only deal with monetary policy -- the amount of money available, and at what cost -- that is, the interest rate.
   Today, the Fed released the minutes of its most recent meeting, offering some hints as to what it plans to do next. A guessing game at best, since the board seldom offers solid suggestions as to what it will do in coming days. There are, however, some hints, and it seems the nation's money manager is satisfied with what it has been doing to stimulate the economy, and may well pull back again in the near future, because economic signals are relatively healthy and that lessens the need for Fed intervention.
   How does the agency do this? Here's a brief summary.

   The Fed attempts to alter the money supply by buying or selling on the open market government bonds that it holds. By buying bonds, the Fed puts more cash into circulation, and by selling bonds it takes money out. In doing this, the nation's central bank changes the number of dollars available to the public, which in turn changes the interest rate.
   Here, the basic economic Law of Supply and Demand comes into play. Since an interest rate is essential the price you pay to borrow money, if there's less of a product (money) available, the price (interest rate) goes up.
   Conversely, when more is available, the price goes down. The economic law is what the Fed relies on when attempting to control interest rates.
   Likewise, an inflated money supply raises the prices of goods and services even as it lowers the interest rate. In short, prices rise to absorb the amount of money available.
   The trick, then, is to balance these opposing forces of money supply with the demand for goods and services (prices and wages).
   Confused yet? It gets better.

   By increasing the supply of money, the Fed hopes to lower interest rates, which encourages more borrowing to finance more projects, which hire more workers, which increases wages, which boosts demand for food, clothing and shelter, which leads to more production, which means lower prices, and around it goes as the nation prospers.
   But the reverse spiral is also possible. Ay, and there's the rub. How to play one trend against the others to stimulate growth but not so much as to topple a sometimes precarious balance.
   And that's just one part of government actions to boost or pummel economic potential. Another part is government spending, also known as fiscal policy.
   The Federal Reserve, as the nation's central bank, sets monetary policy to control the amount of money available. The government itself, however, can take advantage of low interest rates to borrow money for projects that will hire more workers, who then have more wages, and the spiral goes on.
   Once again, however, if fiscal policy is too weak or too strong, the nation's economy can be sent into a downward spiral or too fast an upward growth spiral, leading to bigger problems.
   In addition, if government borrowing is too much, it can crowd out borrowing in the private sector, such that companies cannot get funding for their operations, which means less production, less hiring, few wages, and down we go again.

      So does the central bank coordinate its efforts with the central government? Not so you'd notice. The Fed is an independent body, and it cherishes its independence, resisting any attempt by Congress or the Executive Branch to control its actions. There may occasionally be mutual goals, but usually there are not. And any attempt to politicize the Fed's programs for partisan objectives is a danger to be avoided and stifled whenever possible.