Michelle Bachmann has made some interesting comments while on the campaign trail. Unfortunately, a few of her quips are totally unreasonable. First, Ms. Bachmann hopped on Gov. Rick Perry's back and said "The Federal Reserve has made terrible, grievous errors" in regards to quantitative easing programs because "The dollar has lost 12 percent of its value". Secondly, Ms. Bachmann promised "Under President Bachmann, you will see gasoline come down below $2 a gallon again. That will happen".
Boy oh boy, no Fed and $2 gasoline sounds good right? Wrong. Ms. Bachmann simply fails to understand supply and demand, in both the money market and oil market.
First, let's analyze Ms. Bachmann's claim that the Fed made many mistakes during the crisis. Quantitative Easing uses money within the Fed to purchase long-term assets from Banks - increasing the money supply. The goal of this program is to decrease the long-term interest rates by increasing the quantity of money in the market. As the money supply increases, interest rates decline which induces more domestic investment by private firms. At the same time, as interest rates decline, foreign investors demand less USD as the return is lower and US producers supply more goods as USD is relatively cheaper. This shift in the exchange rate market will lower the USD exchange rate and increase Net Exports.
A summary: Increase in money supply leads to increase in domestic investment (due to falling interest rates), increase in net exports (due to falling USD exchange rates), unambiguous increase in output ( Y = C + I + G + NX!!)
Simply put, the Federal Reserve has increased GDP domestically and has taken actions to save the US from considerable turmoil. The drop in the exchange rate was intended to increase net exports and increase domestic investment. Every economist understands this. Further, without a federal reserve interest rates cannot be controlled – increasing prices will lead hyperinflation. The Fed maintains stable inflationary policies through controlling the money supply.
Next, a simple analysis of the “$2/gallon of gasoline” promise. In the oil market, supply and demand must be equivalent and prices adjust to clear this market. At the current average price of $3.65/gallon, supply must either increase or demand must fall. Reactions to changes in supply or demand depend on the elasticity of these curves – how much prices respond to a given change in input. Bachmann’s promise was based on more domestic drilling – increasing the supply of oil. However, supply of oil is very close to being price inelastic – an increase in supply won’t decrease prices by much.
Ms. Bachmann must have missed class on supply and demand day. Prices don’t necessarily respond by “just increasing supply a little” and decreasing exchange rates don’t yield decreasing output.
Boy oh boy, no Fed and $2 gasoline sounds good right? Wrong. Ms. Bachmann simply fails to understand supply and demand, in both the money market and oil market.
First, let's analyze Ms. Bachmann's claim that the Fed made many mistakes during the crisis. Quantitative Easing uses money within the Fed to purchase long-term assets from Banks - increasing the money supply. The goal of this program is to decrease the long-term interest rates by increasing the quantity of money in the market. As the money supply increases, interest rates decline which induces more domestic investment by private firms. At the same time, as interest rates decline, foreign investors demand less USD as the return is lower and US producers supply more goods as USD is relatively cheaper. This shift in the exchange rate market will lower the USD exchange rate and increase Net Exports.
A summary: Increase in money supply leads to increase in domestic investment (due to falling interest rates), increase in net exports (due to falling USD exchange rates), unambiguous increase in output ( Y = C + I + G + NX!!)
Simply put, the Federal Reserve has increased GDP domestically and has taken actions to save the US from considerable turmoil. The drop in the exchange rate was intended to increase net exports and increase domestic investment. Every economist understands this. Further, without a federal reserve interest rates cannot be controlled – increasing prices will lead hyperinflation. The Fed maintains stable inflationary policies through controlling the money supply.
Next, a simple analysis of the “$2/gallon of gasoline” promise. In the oil market, supply and demand must be equivalent and prices adjust to clear this market. At the current average price of $3.65/gallon, supply must either increase or demand must fall. Reactions to changes in supply or demand depend on the elasticity of these curves – how much prices respond to a given change in input. Bachmann’s promise was based on more domestic drilling – increasing the supply of oil. However, supply of oil is very close to being price inelastic – an increase in supply won’t decrease prices by much.
Ms. Bachmann must have missed class on supply and demand day. Prices don’t necessarily respond by “just increasing supply a little” and decreasing exchange rates don’t yield decreasing output.
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