Explore the connection between the economic indicators and real-world issues. These lessons typically can be done in one class period.


Discount Rate, Federal Reserve, Federal Reserve Structure, Fiscal Policy, Interest Rate, Monetary Policy, Open Market Operations, Reserve Requirements

Current Key Economic Indicators

as 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.

Employment and Unemployment

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 GDP

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.

Federal Reserve

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 decided today to keep its target for the federal funds rate at 1 percent.

Target federal funds rate is 1.0 percent

Target federal funds rate has not changed in the last four meetings

The discount rate is 2.0 percent


The Federal Open Market Committee decided today to keep its target for the federal funds rate at 1 percent.

The Committee continues to believe that an accommodative stance of monetary policy, coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity. The evidence accumulated over the intermeeting period confirms that output is expanding briskly, and the labor market appears to be improving modestly. Increases in core consumer prices are muted and expected to remain low.

The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. However, with inflation quite low and resource use slack, the Committee believes that policy accommodation can be maintained for a considerable period.

Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Ben S. Bernanke; Susan S. Bies; J. Alfred Broaddus, Jr.; Roger W. Ferguson, Jr.; Edward M. Gramlich; Jack Guynn; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; and Robert T. Parry.

This complete press release is available at: www.federalreserve.gov/BoardDocs/Press/monetary/2003/20031209/

Reasons for a Case Study on the Federal Open Market Committee (FOMC)

The target federal funds rate is at a record low as the Federal Reserve monetary policy committee has concerned itself with encouraging the recovery from the 2001 recession and the possibility of experiencing a deflationary period. Recent announcements reflect serious concerns with the state and direction of the economy. The recession is over; concern with the possibility of deflation is reduced; growth in spending and employment has not yet reached robust levels; and yet some observers are beginning to discuss the possibilities of higher interest rates in the near future.

This case study is intended to guide students and teachers through an analysis of the actions the Federal Reserve began to take in January of 2001 in efforts to strengthen the economy. An understanding of monetary policy in action is fundamental to developing a thorough understanding of macroeconomics and the U.S. economy.

Notes to Teachers

The material in this case study in italics is not included in the student version. This initial case study of the semester introduces relevant concepts and issues. Subsequent case studies following FOMC announcements will describe the announcement and add concepts and complexity throughout the semester.

You may wish to use the following larger versions of the graphs and tables from this lesson for overhead projection or handouts in class:

Guide To Announcement

The first paragraph of the December meeting announcement summarizes the current monetary policy changes - this month it is the decision to cut leave the target federal funds rate by 0.5% unchanged at 1 percent. The Federal Reserve Board of Governors also sets the discount rate, through a technical process of approving requests of the twelve Federal Reserve Banks. The discount rate is not mentioned in the announcement and th at implies that it also was cut by 0.5% (to 0.75%) left unchanged at th e is meeting.

In the second paragraph, the Federal Reserve discusses the reasoning behind their decision. The statement that “an accommodative stance of monetary policy, coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity ” shows that the Fed eral Reserve views the recent policy of a decrease in the target federal funds rate followed by a period of constant rates as proving effective. The changes in this announcement are that the members of the Committee state that “output is expanding briskly, and the labor market appears to be improving modestly.” The statement that “output is expanding briskly” compares to the previous “spending is firming”. The previous description of the labor market was that it appears to be stabilizing. In addition, they expect increases in prices to remain low. This is a relatively more positive description of economic conditions than appeared in the announcement following the last meeting in October.

In the third paragraph is the indication of likely future changes. T he Fed eral Reserve indicates that the risks of inflation and slowing spending growth are balanced . Th is can be interpreted as the Committee members believing that they will be unlikely to make additional changes between now and the next meeting at the end of January. After the last meeting the Committee expressed concern with the risk of deflation. Now, however, the Federal Reserve believes that “the probability of an unwelcome fall in inflation has diminished”. Much press attention was given to the continuation of the use of the term “considerable period” to describe how long the Committee believes that interest rates can be left as low as they are. Apparently the Committee does believe that the target federal funds rate will likely continue to be held at 1 percent or close to it for a “considerable period”. inflation (“price stability”) and sustainable growth

showing that the Fed is taking care to avoid overheating the economy in the quest to boost growth. incoming economic data have tended to confirm that greater uncertainty, in part attributable to heightened geopolitical risks, is currently inhibiting spending, production, and employment.” refers to the underlying foreign threats that are hampering economic growth. The FOMC indicates that the long-run prospects are good. Current monetary policy is accommodative neutral - meaning it should permit economic expansion while containing inflation and a return to full strength too quickly . The FOMC members expect continued productivity growth. Both should help the economy return to full strength.

The fourth and fifth paragraph s describe s the votes of the FOMC members on changing the target federal funds rate. In the past, there has been a lag between the announcement and the publication of this information in the minutes. This change, which was implemented last year, is one step in a FOMC trend toward releasing more information immediately following their meetings. All members of the FOMC voted to cut leave the target federal funds rate unchanged.

Data Trends

During the last half of the 1990s, real GDP grew at rates more rapid than those in the first half of the decade. That growth began to slow at the end of 2000. Real GDP increased at annual rates of 4.5 percent and 3.7 percent in 1999 and 2000. During the first three quarters of 2001, real GDP actually decreased. For 2001 as a whole, real GDP increased only by .5 percent. The slowing growth over the last two quarters of 2000 and all of 2001 was one indication of the need to use a monetary policy that would boost spending in the economy. The FOMC responded, beginning in January of 2001, by cutting the target federal funds rate throughout the rest of the 2001.

From January 3 to December 11 of 2001, the Federal Reserve Open Market Committee (FOMC) lowered the target federal funds rate eleven 11 times from 6.50 percent to 1.75 percent , (a total reduction of 4.75 percent). This is at that time, the lowest target federal funds rate in forty years. During the fourth quarter of 2001, real GDP rebounded, but only at an annual rate of 2.0 percent. Real GDP increased only at a rate of 2.2 percent in 2002. At all of the previous 2002 meetings prior to the before the cut at the November meeting , the FOMC decided to leave the federal funds rate unchanged. In November, the target federal funds rate was once again lowered to 1.25 percent. Then in June of 2003, following a first quarter increase of only 2.0 percent, the target federal funds rate was lowered once again, this time to 1 percent. (For more on changes in the rate of growth of real GDP and the recession, see the most recent GDP Case Study.)

Figure 1: The Target Federal Funds Rate and the Discount Rate

Figure 1 shows the path of the target federal funds rate since 1990. The gray areas indicate the recessionary periods in 1990-1991 and in 2001.

The FOMC used policies actively throughout much of the 1990s. The FOMC had lowered the target federal funds rate in a series of steps beginning in July of 1990 until September of 1992, all in response to a recession beginning in July of 1990 and ending in March of 1991. Then as inflationary pressures began to increase in 1994, the Federal Reserve began to raise rates in February. In response to increased inflationary pressures once again in 1999, the Federal Reserve raised rates six times from June 1999 through May of 2000.

A Caution

Much of the attention in the press has been focused on the part of the FOMC statement that expresses less concern with deflation. The press attention centers on a discussion of when the FOMC may begin to increase the target federal funds rate in response to rising concerns with future inflation. For example, one analyst was quoted following the announcement as follows – “Make no mistake, yesterday's statement is immensely significant. The groundwork for the first hike is being laid.”

Much of the recent press attention was also discussing whether or not the FOMC would drop the description of their plans to hold interest rates down “for a considerable period”. They obviously kept that statement in the announcement. We should be cautious in attaching too much attention to any one part of an announcement. It is no surprise that the FOMC will eventually increase the target federal funds rate. However, they have stated that the existing level will continue “for a considerable period” and the minutes of their October meeting indicate a possibility of a constant target federal funds rate throughout much or all of the next year. One of the conclusions was that weaknesses in the labor market might not solved until the latter part of 2005 or even later.


The National Bureau of Economic Research (NBER) announced though its Business Cycle Dating Committee that it had determined that a peak in business activity occurred in March of 2001. That signals the official beginning to a recession. This year it announced that the recession officially ended in November of 2001.

The NBER defines a recession as a "significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade." The current data show a decline in employment, but not as large as in the previous recession. Unemployment has also increased during the period overall. Real income growth slowed but did not decline. Manufacturing and trade sales and industrial production have both declined and now appear to be turning around.

While the common media definition of a recession is two consecutive quarters of decline in real GDP, this recession began before quarterly real GDP was actually reported as having declined.

The previous recession began in July of 1990 and ended in March of 1991, a period of eight months. However, the beginning of the recession was not announced until April of 1991 (after the recession had actually ended). The end of the recession was announced in December of 1992, almost 21 months later. One of the reasons the end of the recession was so difficult to determine was the economy did not grow very rapidly even after it came out a period of falling output and income.

For the full press release from the National Bureau of Economic Research, see: http://cycles-www.nber.org/cycles/recessions.html


Deflation is the opposite of inflation. We experience deflation if prices across the economy, that is, if most prices or prices on average, are falling. This announcement refers to a diminished probability of “an unwelcome fall in inflation.” As recent inflation has been quite low, the FOMC announcements since May have mentioned concerns that inflation might turn into deflation.

Why should we be concerned with falling prices? Lower prices sound good. The concern is that if prices throughout the economy are falling and if consumers and businesses expect prices to continue to fall, they may reduce spending because they expect even lower prices in the near future. That would put further downward pressure on spending, production, and employment and perhaps lead to another recession.

In addition, businesses and individual debtors may face increased pressures. As sales (and incomes) and therefore profits fall, monthly payments on debt do not change. Instead they become an ever-increasing percentage of income and make it more difficult to make timely payments.

Federal Open Market Committee (FOMC)

The primary function of the FOMC is to direct monetary policy for the U.S. economy. The FOMC meets about every six weeks. (The next meeting is January 27 and 28, 2004.) The seven Governors of the Federal Reserve Board and five of the twelve Presidents of the Federal Reserve Banks make up the committee. Governors are appointed by the U.S. President and confirmed by the U.S. Senate. The Boards of each Federal Reserve Bank select the presidents of the banks.

Figure 2: The Federal Funds Rate and the Discount Rate

Tools of the Federal Reserve

For a description of tools of the Federal Reserve, see the October 28, 2003 FOMC Case Study.

Open Market Operations

The Federal Reserve buys and sells bonds and by doing so, increases or decreases banks' reserves and their abilities to make loans. As banks increase or decrease loans, the nation's money supply changes. That, in turn, decreases or increases interest rates. Open market operations are the primary tool of the Federal Reserve. They are often used and are quite powerful. This is what the Federal Reserve actually does when it announces a new target federal funds rate. The federal funds rate is the interest rate banks charge one another in return for a loan of reserves. If the supply of reserves is reduced, that interest rate is likely to increase.

Banks earn profits by accepting deposits and lending some of those deposits to someone else. They sometimes charge fees for establishing and maintaining accounts and always charge borrowers an interest rate. Banks are required by the Federal Reserve System to hold reserves in the form of currency in their vaults or deposits with Federal Reserve System.

When the Federal Reserve sells a bond, an individual or institution buys the bond with a check on their account and gives the check to the Federal Reserve. The Federal Reserve removes an equal amount from the customer's bank's reserves. The bank, in turn, removes the same amount from the customer's account. Thus, the money supply shrinks.

Discount Rate

The discount rate is the interest rate the Federal Reserve charges banks if banks borrow reserves from the Federal Reserve itself. Banks seldom borrow reserves from the Federal Reserve and tend to rely more on borrowing reserves from other banks when they are needed. The discount rate is often changed along with the target federal funds rate, but the discount rate change does not have a very important effect. In this announcement, the discount rate is not changed.

(Note: In January of 2003, the discount rate was changed to a level one percent above the target federal funds rate. The discount rate had normally been about one-half of a percent less than the target federal funds rate. Technical aspects of borrowing from the Fed were also changed at the same time. The basic functions of monetary policy were not changed.)

Reserve Requirements

Banks are required to hold a portion (either 10 or 3 percent of most deposits, depending upon the size of the bank) of some of their deposits in reserve. Reserves consist of the amount of currency that a bank holds in its vaults and its deposits at Federal Reserve banks. If banks have more reserves than they are required to have, they can increase their lending. If they have insufficient reserves, they have to curtail their lending or borrow reserves from the Federal Reserve or from another bank that may have extra, or what are called excess, reserves. The requirement is seldom changed, but it is potentially very powerful.

How does Monetary Policy Work?

Monetary policy works by affecting the amount of money that is circulating in the economy. The Federal Reserve can change the amount of money that banks are holding in reserves by buying or selling existing U.S. Treasury bonds. When the Federal Reserve buys a bond, the seller deposits the Federal Reserves' check in her bank account. As a bank's reserves increase, it has an increased ability to make more loans, which in turn will increase the amount of money in the economy.

Competition among banks forces interest rates down as banks compete with one another to make more loans. If businesses are able to borrow more to build new stores and factories and buy more computers, total spending increases. Consumer spending that partially depends upon levels of interest rates (automobile and appliances, for example) is also affected. Output will tend to follow and employment may also increase. Thus unemployment will fall. Prices may also increase.

When the Federal Reserve employs an expansionary monetary policy, it buys bonds in order to expand the money supply and simultaneously lower interest rates. Although gross domestic product and investment increase, this may also stimulate inflation. If growth in spending exceeds growth in capacity, inflationary pressures tend to emerge. If growth in spending is less than the growth in capacity, then the economy will not be producing as much as it could. As a result, unemployment may rise.

When the Federal Reserve adopts a restrictive monetary policy it sells bonds in order to reduce the money supply and this results in higher interest rates. A restrictive monetary policy will decrease inflationary pressures, but it may also decrease investment and real gross domestic product. See the Inflation Case Study for a more detailed discussion of inflation.

Comparison of Monetary and Fiscal Policy

The FOMC has been reacting to the slowing economy over the past year. While the monetary policy has not been sufficient to prevent a recession, it surely has made the recession milder than it would have been otherwise and has likely contributed to the recession ending sooner.

Fiscal policy, the taxing and spending policies of the federal government, has the potential to influence economic conditions. Throughout this year, there have been debates in Congress about what to do with spending and taxes in order to stimulate spending. These debates continue and little has been accomplished this year. The challenges of quick responses point to one of the key differences between fiscal and monetary policy. Fiscal policy is much more difficult to implement but has a faster effect spending. Monetary policy decisions are much easier to institute and more responsive to economic conditions, but may take longer to have a full effect.

Creation of the Federal Open Market Committee

Creation of the Federal Open Market Committee

See the previous FOMC Case Study for more on the background of the structure of the FOMC.

A Research Project

Look at the last four announcements - all of the announcements since the June 25th lowering of the target federal funds rate. Identify the differences in the announcements. Compare the changes in the announcements to what was occurring in labor markets at the same time.

(The August, September, and October, 2003 press releases are available at: www.federalreserve.gov/BoardDocs/Press/monetary/200 3 /200 30812/ ; http://www.federalreserve.gov/BoardDocs/Press/monetary/2002/20021106/default.htm http://www.federalreserve.gov/BoardDocs/Press/monetary/200 3 /200 3916 / http://www.federalreserve.gov/BoardDocs/Press/monetary/2002/20021106/default.htm ; and http://www.federalreserve.gov/BoardDocs/Press/monetary/200 3 /200 31028 /. http://www.federalreserve.gov/BoardDocs/Press/monetary/2002/20021106/default.htm )

The only differences in the August, September, and October announcements are found in the second sentence of the second paragraph. In August, the announcement states that “…labor market indicators are mixed.” In September, the announcement states that “…the labor market has been weakening.” In October, the description is that “…the labor market appears to be stabilizing.” (The September and October announcements also change the August statement that evidence “shows” that spending is firming to the evidence “confirms” that spending is firming.)

In December, the addition is that the evidence confirms that “…output is expanding briskly, and the labor market appears to be improving modestly.” (There is also an addition that increase in prices are “expected to remain low”.) Finally, the December announcement in the third paragraph does make a change that states the FOMC believes that the probabilities of a fall and of a rise in prices are almost equal, where earlier they were more concerned with the possibility of a fall.

At the August meeting, unemployment had fallen slightly in the previous month and employment was continuing to fall. At the September and October meetings, unemployment continued to decrease, but very gradually. Employment was beginning to increase. At the December meeting, unemployment was still decreasing slowly, but there were two more months of increases in employment, albeit less than the increases necessary to reduce unemployment significantly.


  1. What are the Federal Reserve current observations and concerns?

    [The Federal Reserve is optimistic about future conditions. Output is “expanding briskly”. There is less concern than there has been that deflation is a potential problem.]

  2. What tools can the Federal Reserve use?

    [The Federal Reserve can buy or sell bonds, which in turn lower or increase the federal funds rate. The Federal Reserve can also change reserve requirements and the discount rate.]

  3. If the Federal Reserve becomes concerned about too much growth in spending in the economy, what is it likely to do with its open market operations and the federal funds rate?

    [The Federal Reserve would sell bonds to reduce the money supply and reserves and thus increase the target federal funds rate.]

  4. If the Federal Reserve is concerned about lack of economic expansion and decided to use changes in reserve requirement and the discount rate, what would it do?

    [The Federal Reserve would lower reserve requirements and decrease the discount rate.]

  5. How does an expansion of bank reserves affect spending in the economy?

    [If banks have more reserves, they can make as more loans. As all banks are eager to increase their loans, the increased supply is likely to decrease the interest rates they are able to charge. The increase in loans and the resulting lower interest rates encourage business to borrow and invest and make it easier for consumers to increase their spending.]