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Why monetary policy can tackle longer-term issues for investors

Mayur Sontakke

Daniel Tarullo outlines long-term challenges for the US economy (Part 5 of 6)

(Continued from Part 4)

The role of monetary policy

Daniel Tarullo is a member of the Board of Governors of the Federal Reserve. Other members include Janet Yellen (Chairwoman), Jeremy Stein, and Jerome Powell. The Federal Reserve uses monetary policy as its tool to achieve its dual mandate of maximum employment and price stability. The Fed has kept the Fed Funds rate near zero to boost the recovery. As the economy recovers, inflationary pressures rise, prompting the Fed to increase interest rates. An increase in interest rates would hamper the bond market (BND) and bond ETFs such as the 20+ Year Treasury Bond ETF (TLT), iShares Barclays 1-3 Year Treasury Bond Fund (SHY), iShares Barclays 7-10 Year Treasury Bond Fund (IEF), and iShares Barclays 3–7 Year Treasury Bond Fund (IEI).

Daniel Tarullo delivered a speech on “Longer-Term challenges for the American economy” at the Hyman Minsky conference on the state of U.S. and Global economies held in Washington, DC, on April 9. In this article, we’ll discuss the role of monetary policy in overcoming these challenges.

Tarullo mentioned that the challenges don’t have any easy or rapid solutions. He went on to say, “It is equally apparent that monetary policy cannot be the only, or even the principal, tool in addressing these challenges. But that is not to say it is irrelevant.”

Monetary policy is directed towards achieving the Fed’s dual mandate of employment and price stability. Monetary policy can address cyclical problems such as drops in demand or labor market slack. As long as monetary policy is successful in preventing cyclical issues to be structural (or longer-term), it helps in improving longer-term potential growth rates.

More generally, maximum employment lays a foundation for stronger demand, increased production, increased investments, and improved productivity. A strong labor market can reduce income inequality by offering higher wages to the bottom of the income distribution.

While the accommodative monetary policy of the past five years (maintaining low interest rates) has contributed significantly to recovery in GDP, it hasn’t resulted in a rise in wages. Increases in wages have been low, at just over 2% since the onset of the great recession.

There’s an ongoing debate over how much of the current unemployment is structural and how much is cyclical. Tarullo suggested that policymakers should remain attentive towards evidence that the labor market has already tightened, giving rise to inflationary pressures.

Rises in inflation prompt central bankers to raise interest rates, hampering bond markets (BND)—particularly Treasuries (TLT). In this scenario, investors can put their money in inflation-protected securities and ETFs such as the iShares Barclays Treasury Inflation Protected Securities Fund (TIP).

To learn more about why Tarullo feels the National Investment Agenda is important, read on to the next part of this series.

Continue to Part 6

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