When people talk about the economy, they generally focus on government policies such as taxation and regulation. For instance, Republicans credit President Trump’s tax cuts for the seemingly booming economy and surging stock markets. Meanwhile, Democrats blame “deregulation” for the 2008 financial crisis. While government policies do have an impact on the direction of the economy, this analysis completely ignores the biggest player on the stage – the Federal Reserve.
You simply cannot grasp the economic big-picture without understanding how Federal Reserve monetary policy drives the boom-bust cycle. The effects of all other government policies work within the Fed’s monetary framework. Money-printing and interest rate manipulations fuel booms and the inevitable attempt to return to “normalcy” precipitates busts.
In practice, when the economy slows or enters into a recession, central banks like the Federal Reserve drive interest rates down and launch quantitative easing (QE) programs to “stimulate” the economy.
Low interest rates encourage borrowing and spending. The flood of cheap money suddenly available allows consumers to consume more – thus the stimulus. It also incentivizes corporations and government entities to borrow and spend. Coupled with quantitative easing, the central bank can pump billions of dollars of new money into the economy through this loose monetary policy.
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