Ted Allrich states in his book "Comfort Zone Investing," that the chairman of the Federal Reserve is more powerful than the President of the United States due to his immense control over the monetary system. The ability to control inflation is one reason for this reputation. When prices of basic goods and services begin to rise and inflation encroaches on the country, the Fed has many tools it can use to promote this activity or curb it.
Raise Interest Rates
Raising the interest rate is the primary tool the Federal Reserve uses to impact inflation. High interest rates deter people from borrowing money. When few people are borrowing money and banks are not issuing as many loans, the money supply contracts and the prices of goods and services decline. On the other hand, low interest rates compel people to consider purchasing expensive items including homes and cars. When banks issue loans, this money increases the amount of money in circulation. This expansion of the money supply corresponds with a rise in prices.
Sell Assets
The Federal Reserve can sell its government-backed assets and in doing so, remove them from circulation. Removing money from circulation by contracting the money supply means prices remain stable or in some cases, decrease. A 2010 'Wall Street Journal Market Watch' article explains that the Fed is exerting caution when selling its mortgage-backed securities to avoid rising prices. On the other hand, the Fed buys such assets when it wants to flood the market with liquidity and encourage rising prices.
Considerations
The Federal Reserve is not the only party responsible for managing inflation. Inflation is also a risk when the budget is not balanced and the U.S. is in too much debt. During these times, an enticing way to pay off the debts is through printing more money. Germany printed more money to pay its exorbitant war reparations post-WWI and consequently caused its currency to become worthless. Thus, maintaining a balanced budget and low trade deficit is another way the U.S. can offset the risk of inflation.
Expert Insight
The chairman of the Federal Reserve implements policies based on his economic school of thought. Those who adopt a Keynesian belief towards economics believe inflation is prevented by strict control over the markets and infusing the economy with cash during down times. President Obama's Federal Reserve chairman Ben Bernanke subscribes to this belief. Other chairmen subscribe to Fredrick Hayek's Austrian school of thought, which states the government's role should be limited and the market self-corrects. President Reagan's chairman, Paul Volcker adopted these beliefs.
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