I'm sure you're not five years old, though that term is used to represent a request asking for a much clearer and simpler explanation to a complicated question or problem. ELi5 is very common in the crypto space, however, that's not our focus for today. Let's get into our topic; The challenges the current monetary system faces.

The Problems of the Current Monetary System/Policy.

Lags

The issue with Lags can be seen as the greatest problem the Monetary Authorities are facing. You don't know of a problem when it starts, you only later discover that problem exists, then you move to put a solution in place and even that solution takes a while to be seen or evident in the economy. It usually takes several months for the change effect to be evident. You can decide to work ahead of time by anticipating a problem is coming, and proffering solutions now beforehand. The issue here is that you're not sure of that problem yet, hence, the solution you're providing now, can either make it or break it. So what do you do? That is the problem.

It is easy enough to show a recessionary gap on a graph and then to show how monetary policy can affect aggregate demand and close the gap. In the real world, however, it may take several months before anyone even realizes that a particular macroeconomic problem is occurring. When monetary authorities become aware of a problem, they can act quickly to inject reserves into the system or to withdraw reserves from it.

What does that mean? Monetary Authorities can use the Open market operations to inject or withdraw cash from circulation. Once that is done, however, it may be a year or more before the action affects aggregate demand( before the action spreads and becomes evident ).

The delay between the time a macroeconomic problem arises and the time at which policy makers become aware of it is called a recognition lag. The 1990–1991 recession, for example, began in July 1990. It was not until late October that members of the FOMC noticed a slowing in economic activity, which prompted a stimulative monetary policy. In contrast, the most recent recession began in December 2007, and this time the Fed wanted to be proactive so the Fed easing began in September 2007. In the end, we all know the story, a recession happened, meaning their implementation of the open market operations of credit bank reserves and easing interest rates didn't help but made it worse.

Recognition lags stem largely from problems in collecting economic data. First, data are available only after the conclusion of a particular period. Preliminary estimates of real GDP, for example, are released about a month after the end of a quarter. Thus, a change that occurs early in a quarter will not be reflected in the data until several months later. Second, estimates of economic indicators are subject to revision. The first estimates of real GDP in the third quarter of 1990, for example, showed it increasing. Not until several months had passed did revised estimates show that a recession had begun. And finally, different indicators can lead to different interpretations. Data on employment and retail sales might be pointing in one direction while data on housing starts and industrial production might be pointing in another. It is one thing to look back after a few years have elapsed and determine whether the economy was expanding or contracting. It is quite another to decipher changes in real GDP when one is right in the middle of events. Even in a world brimming with computer-generated data on the economy, recognition lags can be substantial.

I can keep going on and on about how lags have proven to be a big stumbling block for the current monetary system, and how it's almost impossible to not face these problems that can come with lags every now and then in the future. Hence, the current monetary system is primed for failure but can be managed by allowing the U.S. to go into a recession after a couple of decades and only not enter one because of luck. With the U.S. going into a recession, it would mean that the world would most likely enter one as well, like how it has always happened in the past since 1973.

So what exactly is happening to stop or avert this? I'll tell you in a moment. For now, I'll show you more problems with the current Monetary system.

Interest Rates

Interest rates, particularly the federal funds rate, played a key role in recent Fed policy. The FOMC does not decide to increase or decrease the money supply. Rather, it engages in operations to nudge the federal funds rate up or down.

Up until August 1997, it had instructed the trading desk at the New York Federal Reserve Bank to conduct open-market operations in a way that would either maintain, increase, or ease the current “degree of pressure” on the reserve positions of banks. That degree of pressure was reflected by the federal funds rate; if existing reserves were less than the amount banks wanted to hold, then the bidding for the available supply would send the federal funds rate up. If reserves were plentiful, then the federal funds rate would tend to decline. Just like I explained earlier. When the Fed increased the degree of pressure on reserves, it sold bonds, thus reducing the supply of reserves and increasing the federal funds rate. The Fed decreased the degree of pressure on reserves by buying bonds, thus injecting new reserves into the system and reducing the federal funds rate. I'm sure this is crystal clear.

The current operating procedures of the Fed focus explicitly on interest rates. At each of its eight meetings during the year, the FOMC sets a specific target or target range for the federal funds rate. When the Fed lowers the target for the federal funds rate, it buys bonds. When it raises the target for the federal funds rate, it sells bonds.

I still have a few more to share before we go into inflation. Till the next part of the series, I remain your favorite crypto journalist, Clever Abaribote.

Sources: University of Minnesota Libraries.