In December of 1913, the Federal Reserve System (Fed) was created by the Federal Reserve Act. According to Congress, the role of the Federal Reserve System is to promote maximum employment, stability and growth of the economy, and moderate long-term interest rates. The Fed employs Monetary Policy in an effort to manage both the money supply and interest rates while stimulating the economy to operate close to full employment. One school of thought called Monetarism believes that the Federal Reserve should simply pursue policies to eliminate inflation. Zero inflation may help the market to avoid imbalances, stabilize the business cycle, and promote steady growth in our economy. On the other hand, zero inflation may not reduce unemployment. It may not promote a higher rate of saving and investment, and it may increase income inequality by redistributing income to the high-income people from the low-income people. The topic of a zero inflation rate is an especially interesting dilemma at the moment because monetary policy and interest rates remain at center stage of the economic policy debate. During the last recession, the question was how fast and how low the Federal Reserve should lower interest rates. Since the unemployment rate is at a twenty-three year low at the present, the question is now how high the Fed should raise rates.The dominant economic model is the theory of the non-accelerating inflation rate of unemployment, otherwise known as the "natural rate" of unemployment. This theory states that if you try to push the unemployment rate below the natural rate, the result will be an increase in inflation but no permanent fall in unemployment. This is because market forces push the economy back to the natural rate of unemployment. The only effect of sustained monetary policy, therefore, is increased inflation and the fact that policy makers cannot trade more inflation for less employment.The relationship between inflati...
