Evan McLaughlin - Story 2: The Fed’s Dual Mandate

Data Sources

FFR: https://fred.stlouisfed.org/series/FEDFUNDS#

Unemployment Rate: https://www.bls.gov/data/

CPI: https://data.oecd.org/price/inflation-cpi.htm

Introduction

The FED, or the Federal Reserve, operates under a dual mandate laid out by the U.S. Congress. This mandate entails that the FED has two main goals: managing inflation and ensuring full employment. In assessing inflation, we gauge the rate by examining the Consumer Price Index, which measures the percentage shift in the overall price level of goods and services with a one-period lag. The central question addressed in this document pertains to the FED’s ability to successfully pursue both of these objectives simultaneously.

Question 1

Has the FED been able to fulfill the mandate given to it by Congress?

The following set of graphs offers a graphical depiction of significant economic metrics from the past quarter-century. These metrics encompass the unemployment rate, inflation rate, and the federal funds rate. Through this examination, I aim to provide a high-level look at trends over a 25-year timeframe. The objective of is to assess how effectively the Federal Reserve has fulfilled its dual mandate of curbing inflation and sustaining full employment. In its monetary policy arsenal, the Federal Reserve utilizes the federal funds rate as an economic instrument to counter increasing inflation and unemployment rates.

library(ggplot2)
library(plotly)

## Warning: package 'plotly' was built under R version 4.2.3

## 
## Attaching package: 'plotly'

## The following object is masked from 'package:ggplot2':
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##     last_plot

## The following object is masked from 'package:stats':
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##     filter

## The following object is masked from 'package:graphics':
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library(shiny)
library(dplyr)

## 
## Attaching package: 'dplyr'

## The following objects are masked from 'package:stats':
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##     filter, lag

## The following objects are masked from 'package:base':
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##     intersect, setdiff, setequal, union

library(rsconnect)

## Warning: package 'rsconnect' was built under R version 4.2.3

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## Attaching package: 'rsconnect'

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library(tidyr)


fed_funds <-read.csv("https://raw.githubusercontent.com/evanmclaughlin/DATA-608/main/FEDFUNDS(1).csv")

unemployment <- read.csv("https://raw.githubusercontent.com/evanmclaughlin/DATA-608/main/Unemployment-20230924002725_0a52f0.csv")  

cpi <- read.csv("https://raw.githubusercontent.com/evanmclaughlin/DATA-608/main/DP_LIVE_24092023212058014.csv")

# plot fed funds rate, first convert date column

fed_funds$DATE <- as.Date(fed_funds$DATE)

# str(fed_funds$DATE)
ggplot(fed_funds, aes(x = DATE, y = FEDFUNDS)) +
  geom_line() +
  labs(x = "Date", y = "Fed Funds Rate",
       title = "Fed Funds Rate Since 1998")

# next, we'll do unemployment
unemployment$rate <- as.numeric(unemployment$rate)
#unemployment$year <- as.Date(unemployment$year)
unemployment$month <- as.Date(unemployment$month)

#str(unemployment)

# Create a line plot for the Unemployment Rate
ggplot(unemployment, aes(x = month, y=rate)) + geom_line() +
  labs(x = "Date", y = "Unemployment Rate",
       title = "Unemployment Rate Since 1998")

# now let's bring in CPI

cpi$TIME <- as.Date(cpi$TIME)
cpi$Value <- as.numeric(cpi$Value)

# str(cpi)
ggplot(cpi, aes(x = TIME, y = Value)) +
  geom_line() +
  labs(x = "Date", y = "CPI",
       title = "Inflation Since 1998")

The Consumer Price Index (CPI) illustrated above serves as an economic gauge that quantifies the average expenses associated with goods and services. Of particular significance is the annual percentage change in the CPI, which tracks whether the prices of goods and services ascend or descend over time.

In the graph above, we both gradual and sudden upswings in the CPI starting from 1998. Subtle upward trajectories provide an indicator of the overall escalation in the cost of living and underscores inflation’s pivotal role in gauging the impact of higher prices on the economy. It also tracks with our understanding of stimulated demand, a good example of which is illustrated by the large jump in CPI during the Covid-19 pandemic wherein large cash disbursements were distributed to Americans. With no corresponding stimulus applied to the supply side, prices understandably jumped. Contrast this with the Financial Crisis of 2008, where there was no similar aid packages and a major recession, CPI dropped precipitously.

We would benefit from a side-by-side look at the Fed Funds Rate and Inflation to see how the Central Bank uses this monetary tool to control both inflation and unemployment.

#combine datasets

names(fed_funds) <- c("Date", "Fed_Funds_Rate")
names(unemployment) <- c("Date", "Unemployment_Rate")
cpi2 <-cpi[,0:-5]
names(cpi2) <-c("Date", "CPI")

combined <- merge(merge(fed_funds, unemployment, by = "Date", all = TRUE), cpi2, by = "Date", all = TRUE)


combined$Date <- as.Date(combined$Date)

combined_data_long <- combined %>%
  gather(Variable, Value, -Date)

ggplot(combined_data_long, aes(x = Date, y = Value, color = Variable)) +
  geom_line() +
  labs(x = "Date", y = "Value") +
  facet_wrap(~Variable, scales = "free_y", ncol = 1) +
  theme_minimal()

In these plots, we can observe a positive (if somewhat lagging) correlation between the inflation rate and the federal funds rate, as the Federal Reserve tries to play catch up in order to tame inflation. This decision serves as a metaphorical brake on economic activity, raising borrowing costs, which subsequently discourages spending and investment. This measure is taken in an attempt to help curb inflation. However, it’s essential to note that the effects of policy changes and rate adjustments are not immediate and can have delayed impacts. Therefore, the FED must strike a delicate balance in its efforts to control inflation while maintaining full employment. We see the inverse relationship between Unemployment and the FFR in situations such as the Financial Crisis and in the early days of the pandemic, wherein the Fed slashed rates in response to large spikes in unemployment.

Conclusion

As evident from the visual aids, the Federal Reserve operates under a challenging, seemingly contradictory, mandate set forth by the U.S. Congress. Focusing solely on the Federal Funds Rate as the primary economic instrument in this analysis, we can conclude that the Federal Reserve exhibits a moderate level of effectiveness in its efforts to manage inflation and sustain the employment rate. It is important to acknowledge that numerous economic and non-economic factors exert influence on both inflation and unemployment, necessitating a broader array of economic tools beyond the federal funds rate to effectively address these complex dynamics.