This lesson focuses on the May 1, 2013, press release by the Federal Reserve System's Federal Open Market Committee (FOMC) on the current Federal Reserve monetary policy actions and goals, and specifically, the federal funds rate target. This lesson is intended to guide students and teachers through an analysis of the actions the Federal Reserve is taking and can take in influencing prices, employment, and economic growth. Through this lesson, students will better understand the dynamics of the U.S. economy, current economic conditions and monetary policies.
- Explain the meaning of the May 1, 2013, Federal Open Market Committee decision concerning the target for the federal funds rate.
- Identify the current monetary policy goals of the Federal Reserve and the factors that have recently influenced monetary policy goals.
- Identify the current actions taken by the Federal Reserve to achieve its monetary policy goals.
- Explain the intended effects of open market operations.
Current Key Economic Indicatorsas of May 5, 2013
On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers decreased 0.2 percent in March after increasing 0.7 percent in February. The index for all items less food and energy rose 0.1 percent in March after rising 0.2 percent in February.
Total nonfarm payroll employment rose by 165,000 in April, and the unemployment rate was little changed at 7.5 percent. Employment increased in professional and business services, food services and drinking places, retail trade, and health care.
Real gross domestic product increased at an annual rate of 2.5 percent in the first quarter of 2013 (that is, from the fourth quarter to the first quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 0.4 percent.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent...
The Federal Open Market Committee (FOMC) of the Federal Reserve System (Fed) meets approximately every six weeks to determine the nation's monetary policy goals, and specifically to set the target for the federal funds rate (fed funds rate). The fed funds rate is the interest rate at which banks lend their balances at the Federal Reserve to other banks, usually overnight.
The FOMC has maintained the federal funds rate target at a range of 0 to 1/4 percent since its December 16, 2008 meeting. The fed funds rate has been kept at this historically low level due to the long period low and sometimes negative real GDP growth, significant numbers of non-farm employment losses, and a very high unemployment rate.
This lesson focuses on the May 1, 2013, press release by the Federal Open Market Committee on the current Federal Reserve monetary policy actions and goals.
[Note to teacher: In the second semester of the 2012-2013 school year (January-May), there will be three Focus on Economic Data lessons regarding the Federal Reserve and Monetary Policy. In addition to reporting the most recent FOMC decision, this focus on economic data will include an introduction to the structure and functions of the Federal Reserve System, the FOMC and monetary policy tools.
NOTE: When necessary, the FOMC holds unscheduled face-to-face or conference call meetings to make more timely policy decisions in response to unusual economic events or conditions. The policy decisions made as a result of any of these unscheduled meetings will be included in the lesson on the next scheduled meeting.]
- FOMC Monetary Policy press release, May 1, 2013: www.federalreserve.gov/monetarypolicy/maturityextensionprogram.htm
Board of Governors of the Federal Reserve System: This webpage introduces each member of the board.
Federal Reserve Resources for Educators: Here you can find links to instructional materials and tools that can increase your understanding of the Federal Reserve, economics and financial education.
Open Market Operations: This page provides the Federal Reserve's definition and examples of Open Market Operations.
National Economic Indicators: This Federal Reserve Bank of New York webpage explains some of the economic indicators that are used to formulate the nation's monetary policy.
Federal Reserve Consumer Information and Publications web links: This Federal Reserve site provides information, publications, and web links for consumers.
New York Fed: Open Market Operations: This page provides detailed information on open market operations.
About the FOMC: This Federal Reserve page provides detailed information on the FOMC.
First, a Quick Review of Recent Monetary Policy History
On December 1, 2008, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) declared that the U.S. economy reached a peak in the business cycle in December, 2007, and a recession had begun.
At its December 8, 2008, meeting, the Federal Open Market Committee established the target for the federal funds rate at a range of 0 to 1/4 percent. This historically low fed funds rate target was aimed directly stimulating the economy through lower interest rates. The Fed has maintained at this low level for the federal funds rate to this time.
On September 20, 2010, the Business Cycle Dating Committee of the National Bureau of Economic Research determined that a trough in business activity occurred in the U.S. economy in June, 2009, and that the 2008-2009 recession had ended.
After the "official" end of the recession, the FOMC's target for the federal funds rate has not changed. Other strategies to improve banking system liquidity and stimulate economic growth and employment have been added to the Fed's tool box.
[Teacher Note: Ask your students if they feel that the U.S. is still in a recession? What evidence do they have?]
What did the FOMC have to say, more than three years after pushing its primary tool down to a record low in order to reduce interest rates and stimulate credit markets?
Remember, the primary monetary policy goals of the Federal Reserve, as established by the Employment Act of 1946, are to "promote maximum employment, production, and purchasing power." In other words, policies should create jobs, increase output, and keep the price level stable.
[Teacher Note: For information about the Employment Act of 1946, see the Federal Reserve Bank of St.Louis online article, “The Employment Act of 1946: Some History Notes,” by C. J. Santoni (November, 1986). ' ]
Federal Open Market Committee “Monetary Policy” Statement
Released: May 1, 2013
Note: Unless otherwise cited, quoted material in this lesson is from the FOMC's May 1, 2013, monetary policy press release.
The FOMC announced, "Information received since the Federal Open Market Committee met in March suggests that economic activity has been expanding at a moderate pace."
[Teacher Note: Ask your students: What does "expanding at a moderate pace" mean? A dictionary defines "moderately" in this context as, "a: tending toward the mean or average amount or dimension; b: having average or less than average quality : mediocre"]
[Definition source: Merriam-Webster Online Dictionary, www.merriam-webster.com/dictionary/moderately?show=0&t=1335377457]
[Teacher Note: The consensus is that a real GDP growth rate of about 3 peecent is necessary to maintain full employment and to keep the economy stable. In Q1 2013, U.S. real GDP grew at 2.5 percent (firdst estimate). Ask your students what can happen if the economy grows too slowly and the population continues to grow at a normal pace.]
More details from the May 1 FOMC announcement, "Labor market conditions have shown some improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Inflation has been running somewhat below the Committee's longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable."
Inflationary pressures have not been strong enough for the FOMC to choose a higher federal funds rate target. The trade-off between inflation and growth as potential policy targets has continued to lean toward growth.
The FOMC then commented on its progress toward achieving its macroeconomic goals - fostering maximum employment and maintaining price stability.
"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee continues to see downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective."
The Fed will continue its "Large Scale Asset Purchases" program to use its balance sheet to improve the stability of the banking system and encourage banks to make loans.
"To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."
What about the Future?
"The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives."
[Teacher Note: Ask your students to explain why the FOMC continues to be concernedf about possible price instability. What might the FOMC do if inflation is a stronger possibility?]
The Federal Finds Rate Target
Remember, the federal funds rate the interest rate at which depository institutions (member banks) lend balances to each other overnight. The member banks must meet their reserve requiremnts at the end of each day. The FOMC establishes the target rate for trading in the federal funds market.
"To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent."
Figure 1, below, shows the recent history of the federal funds rate target, pror to and after the recent recession.
[Teacher Note: Is there any potential problem when the FOMC announces a specific time-frame for the current policy or a goal of a specific unemployment rate? Is a less specific statement like "extended period" better? Some argue that planners, investors, employers, etc., may respond more positively if they know more about future policy. The specific date may reduce their uncertainty about the economy. Do you agree or disagree?]
The FOMC vote was not unanimous. There was one dissenter.
"Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations." (Esther L. George is President and Chief Executive Officer of the Federal Reserve Bank of Kansas City.)
[Teacher Note: The Federal Reserve Board of Governors has produced an online video program explaining the "maturity extension," or "Large Scale Asset Purchases" monetary policy programs.[ www.federalreserve.gov/faqs/money_15070.htm ]
What Will the Fed Look For in the Future?
When assessing the health of the economy and the impact of past, current an future monetary policy actions, the FOMC will look closely at GDP growth, employment/unemployment, and other economic data.
Figure 2, below, shows the recent history of growth rates of U.S. real gross domestic product (real GDP). How have the FOMC decisions reflected the real GDP growth pattern?
[Teacher Note: Ask your students if a 2.5 percent real GDP growth rate enough?]
Figure 3, below, shows the recent history of monthly U.S. unemployment rates.
[Teacher Note: Ask your students: If the U.S. unemployment rate remains as high as 7.5 percent, how will this potentially impact consumers and producers?]
U.S. output is increasing, although erratic from quarter to quarter. The U.S. unemployment rate continues to remain very high. Look again at Figures 2 and 3. Can you see the time period of the recession, December, 2007 through June, 2009?
The FOMC has kept the federal funds rate target at a very low level of 0 to .25 percent during the recession and to the present time, but the economy continues to recover very slowly. Thus, the Fed continues a low interest rate policy that "accommodates" growth. QE2 (the second round of quantitative easing), purchases of almost $800 billion in securities, intended to provide more market liquidity has officially ended, but continued policies to strengthen the banking system and promote growth continue.
In the past year, the Fed has enacted policies to purchase shorter term securities ad to lengthen the maturity of the Fed's portfolio. The "Maturity Extension Program and Reinvestment Policy " program is ultimately intended to increase bank lending.
Is there a threat of inflation? Take a look at the recent history of changes in the price level, as measured by the CPI-U, Figure 3, below. The majority of the increases in the price level for the past two months has been energy and food prices.
See Figure 4, below, for the recent history of chages in the U.S. price level.
If you leave out the highly volatile energy (especially gasoline) prices over this time period, there has been very little inflation and occasionally some concern about the prospects for deflation. Recently, many observers have feared a recurrence of inflation, driven by energy prices and continued government budget deficits.
[Teacher Note: Ask your students: Are you worried about inflation? How have higher gasoline or other prices affected you and your family?]
[Teacher Note: See the most recent EconEdLink lessons on the consumer price index, real GDP growth, and unemployment and employment for more detail on these macroeconomic measurements. EconEdLink.]
[Note to teacher: Students can read the FOMC policy statements over the past couple of years to track the beginning and progress of the current recession. They may note the slight
changes in the statements that signal future direction. http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm ]
What Are the Monetary Options?
What can the Fed do with its traditional tools to stabilize the economy?
Stimulatory Policy Actions - usually aimed at promoting economic growth:
• Buy securities
• Lower the discount rate
• Lower bank reserve requirements
Contractionary Policy Actions - usually aimed at reducing inflation:
• Sell securities
• Raise the discount rate
• Increase bank reserve requirements
How would each of the above policy tools (actions) impact the economy?
[Teacher Note: The Federal Reserve Bank of Philadelphia has published an online lesson, "Monetary Policy." Description: "Working in groups, students develop an understanding of monetary policy. Students learn about the indicators the Fed uses to determine what changes, if any, should be made to the course of monetary policy." Link: www.federalreserveeducation.org/resources/detail.cfm?r_id=53368c4c%2Dc844%2D43c7%2Da904%2D7b92bbd15619 ]
This FOMC monetary policy announcement began with a quick assessment of current U.S. economic conditions. "Information received since the Federal Open Market Committee met in March suggests that economic activity has been expanding at a moderate pace."
Previous FOMC statements have also referred to a "moderate pace" of growth, after a period of slow growth. The beginning of the May 1 statement was optimistic, but still cautious. The rate of U.S. real GDP growth has been erratic and the unemployment rate remains at 7.5 percent. Job growth in April, 2013, was much better than the previous month, but a clear pattern of growth has not yet been identified.
The current monetary policy continues to be "accommodative." Low interest rates and other policies to encourage lending and investment are focused directly on the Fed's goals to promote economic growth and full employment.
The FOMC federal funds rate action in May was to keep the target range for the federal funds rate at 0 to 1/4 percent "at least as long as the unemployment rate remains above 6-1/2 percent ." Previous FOMC statements have more clearly described their long-term policy as "at least through late 2014." Many have interpreted this to mean that the FOMC wants to provide some policy stability to the benefit of planners, investors, lenders and borrowers. Stable policies can reduce the risk of decision-making.
Despite what may seem like a more optimistic view, Chairman Ben S. Bernanke and the FOMC recognize the potential threats to the U.S. and global recovery, and reaffirmed that the Fed is ready to act if economic growth slows or if the threat of inflation worsens.
[Teacher Note: Ask your students: If the Fed has to make a decision about whether to promote economic growth or stop inflation, which should be the priority? They should be able to describe the trade-off the Fed will face.]
Idea #1. The Federal Reserve Bank of Philadelphia has published an online activity called "The Case of the Gigantic $100,000 Bill." In this lesson, students participate in a demonstration of the money creation process using a large $100,000 bill. Expansions of the money supply caused by successive deposits and loans are traced on the board so that students can observe the process. Students learn to calculate the upper bound of the money creation process using the simple money multiplier.
Idea #2. The Federal Reserve Bank of San Francisco publishes a website called "The Economy: Crisis and Response," with information about the Fed's policies during the recession and banking crisis.
Description: "The financial market turmoil that began in 2007 led to a severe global economic downturn. The causes of the crisis, the effects on global financial markets, and the spillover to the economy are examined here."
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