This lesson focuses on the April 30, 2008, announcement by the Federal Open Market Committee on the current Federal Reserve monetary policy actions and goals. 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. An understanding of monetary policy in action is fundamental to developing a thorough understanding of macroeconomics, the dynamics of the U.S. economy, and current economic conditions.

KEY CONCEPTS

Central Banking System, Discount Rate, Economic Growth, Federal Reserve, Federal Reserve Structure, Inflation, Macroeconomic Indicators, Monetary Policy, Open Market Operations, Price Stability, Reserve Requirements, Tools of the Federal Reserve, Trade-offs among Goals

STUDENTS WILL

  • Identify the current monetary policy goals of the Federal Reserve and the Federal Open Market Committee.
  • Determine the factors that have influenced monetary policy goals.
  • Identify the policy options available to the Federal Reserve to stimulate the economy.
  • Identify the policy trade-offs the Federal Reserve must consider under the current economic conditions.

Current Key Economic Indicators

as of May 5, 2013

Inflation

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...

INTRODUCTION

Federal Reserve Monetary Policy News Release: April 30, 2008

'The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.'

MATERIALS


Key Economic Indicators

as of February 20, 2009

Inflation

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4 percent in January, before seasonal adjustment. The January level of 211.143 was virtually unchanged from January 2008.

Employment and Unemployment

Nonfarm payroll employment decreased by 598,000 in January and the unemployment rate rose from 7.2 to 7.6 percent.

Real GDP

Real gross domestic product decreased at an annual rate of 3.8 percent in the fourth quarter of 2008. In the third quarter, real GDP decreased 0.5 percent.

Federal Reserve

At its January 28, 2009 meeting, the Federal Open Market Committee decided to keep its target range for the federal funds rate at 0 to 1/4 percent.

PROCESS

Federal Reserve Monetary Policy News Release: April 30, 2008

'The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.'

Rationale for a Focus on Economic Data on the Federal Open Market Committee

Following Federal Open Market Committee announcements, newspapers across the country have front-page stories about Federal Reserve actions to change the target for interest rates with a goal of either boosting spending and employment in the U.S. economy or slowing growth in spending and employment. The announcements often reflect serious concerns with the state and direction of the economy and recommend appropriate policy actions.

This focus on economic data 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. An understanding of monetary policy in action is fundamental to developing a thorough understanding of macroeconomics and the U.S. economy.

[Note to Teacher:

The material in this lesson in italics is not included in the student version. Subsequent focus on economic data following FOMC announcements will describe the announcement and add concepts and complexity throughout the semester. This case adds an explanation of the discount rate and a comparison with the previous announcement.

The complete FOMC press release of April 30, 2008 is available at:
www.federalreserve.gov/newsevents/press/monetary/20080318a.htm

A 'basis point' is 1/100 of one percent. A 50 basis point change in an interest rate is the same as a change of .5 (1/2) percent. In this lesson, the federal funds rate change will be referred to as either basis points or as a percentage change.]


The Federal Reserve and Monetary Policy

The Federal Open Market Committee (FOMC) of the Federal Reserve System (Fed) meets eight times annually, approximately every six weeks, to review economic and financial conditions, assess the risks to the nations' long-run goals of price stability, full employment and sustainable economic growth, and determine the appropriate stance of monetary policy.

The Federal Reserve influences the demand for and supply of the balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

The Federal Reserve's structure and monetary policy tools are discussed later in this focus on economic data.

The Current U.S. Monetary and Financial Situation

In the April 30 announcement, the FOMC commented, 'Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.' The economy was characterized as 'weak,' primarily due to less household consumption and business investment.

In it's April 30, 2008, press release, The Bureau of Economic Analysis (BEA) reported that real personal consumption expenditures increased 1.0 percent in the first quarter, compared with an increase of 2.3 percent in the fourth quarter of 2007. Durable goods decreased 6.1 percent, in contrast to an increase of 2.0 percent in the previous quarter. Nondurable goods decreased 1.3 percent, in contrast to an increase of 1.2 percent in the previous quarter. On the positive side services increased 3.4 percent, compared with an increase of 2.8 percent. Source: www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

The BEA also reported that real nonresidential fixed investment decreased 2.5 percent in the first quarter, in contrast to an
increase of 6.0 percent in the fourth. Nonresidential structures decreased 6.2 percent, in contrast to an increase of 12.4 percent. Equipment and software decreased 0.7 percent, in contrast to an increase of 3.1 percent. Real residential fixed investment decreased 26.7 percent, compared with a decrease of 25.2
percent.

The Business Cycle

The economic data considered by FOMC indicates a trend toward very slow growth. Clearly, the United States is in a period of economic slowdown, and many say, a recession. The National Bureau of Economic Research (NBER) defines a recession as 'a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.'

In a business cycle, recession begins after the economy reaches a peak of activity (growth) and ends as the economy reaches its trough (low point). Between trough and peak, the economy is in an expansion as it grows. Expansion is the normal state of the economy. The decline of activity is a recessionary period, if not technically a 'recession.' Recent recessions have been brief and infrequent. Are we in one now?

[Note to teacher: The April 30 BEA announcement is discussed in the EconEdLink Focus on Economic Data on GDP, dated April 30, 2008.]

What is the 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 May 9, 2008.) The seven Governors of the Federal Reserve Board and five of the twelve Presidents of the Federal Reserve Banks make up the voting membership of the FOMC. The non-voting presidents take part in the discussion.

The seven members of the Board of Governors are appointed by the President and confirmed by the Senate to serve 14-year terms of office. Members may serve only one full term, but a member who has been appointed to complete an un expired term may be reappointed to a full term. The President designates, and the Senate confirms, two members of the Board to be Chairman and Vice Chairman of the Federal Reserve, for four-year terms.

The seven Board members constitute a majority of the 12-member FOMC. The other five members of the FOMC are Reserve Bank presidents, one of whom is always the president of the Federal Reserve Bank of New York. The other Bank presidents serve one-year terms on a rotating basis. Traditionally, the Chairman of the Board of Governors serves as the Chairman of the FOMC.

The staff of the Federal Reserve implements the recommended policies. Open market operations (buying and/or selling securities) is conducted through the Federal Reserve Bank of New York.

FOMC Policy Trends

The FOMC used policies actively throughout much of the 1990s and the last several years. The FOMC 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. See figure 1 showing changes in the target. (The periods of the 1990-1991 recession and the 2001 recession are shown in gray on the graph.)

figure1

As inflationary pressures began to increase in 1994, the Federal Reserve began to raise rates, reaching 5 1/4 percent in mid-2007. The FOMC kept the fed funds rate steady at 5-1/4 percent in June and August, 2007.

In September, 2007, the FOMC began a series of rate cuts in response to slowing growth and tightening of credit conditions with 'the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.'

The FOMC reduced the rate at the October and December meetings, and lowered the rate by a total of 1-1/4 percent in two January 2008 meetings. One of the January meetings was not on the original meeting schedule, but was held primarily in response to the growing financial market problems and 'credit crunch.' In March, the FOMC lowered the rate by an additional 3/4 percent to the rate of 2 1/4 percent, the rate that was in effect until the current announcement.

Monetary Policy Goals: Growth vs. Inflation?

The April 30 FOMC announcement included some words of caution about inflation. 'Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.'

In recent years, inflation has been the number one concern of Federal Reserve policies. The 1990s were a period of steady growth and low inflation. In the 2000s, Fed policy to stimulate growth did not seem to result in rising prices until very recently. A variety of factors, including investment banking/credit issues, growth in key developing nations and energy demand have pushed price levels upward.

When the Fed uses a term like 'uncertainty,' it often means that producers, lenders and others will build some 'risk premium' into contracts, prices and interest rates to mitigate potential risk. The Fed indicates that continued inflationary pressures may result in a change in the course of monetary policy. Is there a trade-off between policies to counter inflation and stimulate growth?

Monetary Policy Tools of the Federal Reserve

The Federal Reserve has three primary tools to use to implement monetary policy.

  • Open market operations
  • Discount rate
  • Reserve requirements

In addition, the Federal Reserve has recently introduced a new policy tool called the Term Auction Facility (TAF). The Fed auctions a quantity of credit to eligible borrowers for a term substantially longer than overnight. Banks can use a wide variety of collateral, including mortgages, to secure the loans. The TAF was developed to provide additional liquidity to banks, primarily in response to the tightening credit market and 'sub-prime' problems.

Open Market Operations

The Federal Reserve buys and sells government securities and by doing so, increases or decreases banks' reserves and the banks' abilities to make loans. As banks increase or decrease loans, the nation's money supply increases or decreases. That, in turn, decreases or increases interest rates. The purchase and sale of bonds by the Federal Reserve is called 'open market operations.' The Federal Reserve is 'operating' by buying or selling securities in the 'open market.'

When the Federal Reserve sells a bond, an individual or institution buys the bond with a debit on their account and transfers the funds 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 account of the customer who purchased the bond. Thus, the money supply decreases and interest rates increase.

The opposite occurs when the Federal Reserve buys a bond. The Federal Reserve gives funds to the seller of the bond. The seller deposits the funds in their account. Their bank adds the amount to deposits and thus the money supply increases. The bank also presents the funds back to the Federal Reserve, which in turn adds the amount to the bank's reserves. Because the bank has to keep only a portion of those reserves, the bank can make loans with the remainder. Thus the money supply expands even further. As banks make more loans, interest rates fall.

Open market operations are the primary tool of the Federal Reserve. It is a tool that is often used and is quite powerful. This is what the Federal Reserve actually does when it announces a new target for the 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 because the Federal Reserve has sold bonds, that interest rate is likely to increase. If the supply of reserves is increased because the Federal Reserve has purchased bonds, that interest rate is likely to decrease.

Recent FOMC policy actions have been intended to increase bank reserves and lower interest rates, in order to stimulate the economy, maintain stability in the banking system, and to relieve the so-called 'credit crunch'.

The Discount Rate

The Federal Reserve FOMC announcement refers initially to the change in the federal funds rate target. The announcement may also include a change in the Fed's discount rate.

The discount rate is the interest rate the Federal Reserve charges banks if banks borrow reserves from the Federal Reserve itself. Banks may need to borrow reserves if they have made too many loans, have experienced withdrawals of deposits or currency, or have had fewer deposits than they expected. Banks can borrow reserves from the Federal Reserve or from other banks.

In reality, banks seldom borrow reserves from the Federal Reserve and tend to rely more on borrowing reserves from other banks when they are needed. They will still pay an interest rate (the federal funds rate), but that is a rate determined in the market for reserves and influenced by the open market operations of the Federal Reserve.

From 2003 until mid-August 2007, the discount rate was almost always 1.0 percent above the federal funds rate. From August 17, 2007 until the current FOMC announcement rate, the discount rate has stayed at ½ percent higher than the federal Funds rate.

Figure 2 shows the discount rate along with the federal funds rate. Notice that the discount rate typically changes along with the target for the federal funds rate.

figure2

Reserve Requirements

Banks are required by law to hold a portion of some of their deposits in what are called reserves. The portion varies depending upon the type of deposits and the size of the bank. Most are required to have either 3 or 10 percent of their deposits on reserve, depending on the size of the accounts. Reserves consist of the amount of currency that a bank holds in its vault and the bank's deposits at Federal Reserve banks. The required reserve is the portion of a bank's deposits that cannot be loaned to other customers.

If banks have more reserves than they are required to have, they can increase their lending. If they have insufficient reserves, that is, less than they are required to have, they have to curtail their lending or borrow reserves from the Federal Reserve or from another bank. If another bank has more reserves than they are required to maintain, those extra reserves are called excess reserves. The reserve requirement is seldom changed, but it has a potentially very large effect on the ability to make loans and thus on interest rates.

If the Federal Reserve were to increase the reserve requirements, banks would have to curtail loans and the money supply would shrink. If the reserve requirements were lowered, banks would have excess reserves and they could increase the amount and number of loans they make.

[Note to teacher: For more background on the Federal Reserve's monetary policy responsibilities, go to: www.federalreserve.gov/monetarypolicy/default.htm

For links to Federal Reserve monetary policy teaching resources for use in the classroom, go to
http://federalreserveeducation.org/ .]

How Does Monetary Policy Work?

Monetary policy works by affecting the amount of money that is circulating in the economy, the level of interest rates, and changes in spending. 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 Reserve's check in her bank account. The bank's deposits and reserves increase. The bank then has an increased ability to make 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, machines, and tools, total spending increases. Consumer spending that partially depends upon levels of interest rates (automobile and appliances, for example) is also affected. Output will likely increase as spending increases. In this case, unemployment will fall. There may also be some upward pressure on prices.

When the Federal Reserve adopts a restrictive monetary policy, it sells bonds in order to reduce the money supply. This results in higher interest rates and less spending. A restrictive monetary policy will decrease inflationary pressures, but it may also decrease investment spending and cause real gross domestic product to decrease or to increase more slowly.

[Note to teacher: See the most recent Inflation focus on economic data for a more detailed discussion of the price level and inflation.]

Monetary Policy vs. Fiscal Policy

The FOMC uses monetary policies to react to a slowing economy by expanding the money supply, lowering interest rates, and thus encouraging increased spending. The FOMC reaction to increasing inflationary pressures is to decrease the money supply, raise interest rates, and thereby slowing growth in spending.

Another set of policy options, fiscal policy, is the taxing and spending policies of the federal government. Those policies also have the potential to influence economic conditions whether deliberately or as an unintended consequence of changes in taxes and spending adopted for reasons other than to influence economic conditions. If the economy is entering a recession, fiscal policy response might be to increase government spending and to lower taxes. If spending in the economy is growing too rapidly, the fiscal response might be to decrease government spending and to increase taxes.

In those processes, there will be debates in Congress about what to do with spending and taxes in order to stimulate or slow overall spending in the economy. These debates normally take a substantial amount of time. This lag points to one of the key differences between fiscal and monetary policy. Fiscal policy is much more difficult to implement but once the decision is made, it can have an effect quickly. Monetary policy decisions are much easier to institute and more responsive to economic conditions, but may actually take longer to change spending once the decision is made.

Fiscal policy (changing taxes and government spending) also has a significant lag time. It typically has a long policy lag (the time it takes Congress to approve a tax or spending change) and a short expenditure lag (the time it takes consumers to experience the tax changes and government to change spending). The combined lags may be anywhere from one to almost five years.

Recently, Congress is authorized the use of an income tax rebates to stimulate the economy in a time of very slow growth and increasing unemployment. The rebate is intended to put more cash in the hands of consumers so that they will demand more goods and services. Rebates of up to $600 will be sent to taxpayers beginning in May, 2008.

The Monetary Policy Debate

Since the passage of the The Employment Act of 1946 (U.S. Code Title 15 Section 1021), it has been the mandate of the federal government 'create and maintain useful employment, with fair compensation for the people employed, and to promote maximum employment, production, and purchasing power.' This legislation has evolved into the current system of using fiscal and monetary policies to stabilize the economy and promote growth.

As a requirement of the Employment Act of 1946, the Chairman of the Federal Reserve Board regularly testifies before Congress on the state of the economy and Federal Reserve policies. This testimony draws considerable press attention, as do many public statements by Fed board members. The press, businesses and many in the public look for information about the direction of Fed policies between regular FOMC announcements.

In December, 2003, when former Federal Reserve Chariman Allan Greenspan characterized stock market investors as 'irrationally exuberant,' it was widely interpreted as a negative comment about the stability of economy.

[Note to teacher: For more about the Employment Act of 1946, go to the Federal Reserve Bank of St. Louis web site, http://research.stlouisfed.org/publications/review/86/11/Employment_Nov1986.pdf .]

Monetary policy is based on the assumption that the level of economic activity and the health of an economy can be impacted by changes in the money supply. The Federal Reserve attempts to influence money supply through monetary policies such as open market operations, the discount rate and bank reserve requirements. Money supply changes influence credit creation and the overall level of economic activity.

Economists constantly debate importance to the measurements of the money supply. M1 is the currency in circulation and in easily accessible deposit accounts. More broad measurements such as M2 and M3 include less liquid money supply, such as term deposits and money market mutual funds.

The debate extends from the appropriateness of central bank intervention in the economy to its effectiveness, considering the lengthy time lags inherent in the monetary policy process. History has shown that such intervention has been effective in times of extreme inflation and recession. The question is always one of timing - when and how much intervention is necessary. In a global economy, can the Federal Reserve effectively implement monetary policy to achieve its domestic stabilization and growth goals?

A 2005 report on 'The Effectiveness of Monetary Policy,' by Robert H. Rasche and Marcela M. Williams from the Federal Reserve Bank of St. Louis , sums up the debate. 'The case for consistently effective short-run monetary stabilization policies is problematic – there are just too many dimensions to uncertainty in the environment in which central banks operate.'

For the full Federal Reserve Bank of St. Louis report, go to: http://research.stlouisfed.org/wp/2005/2005-048.pdf .

[Note to teacher: For interactive student exercises about the Federal Reserve and monetary policy, go to the web page: http://federalreserveeducation.org/resources/topics/teacher_monetary_policy.cfm .]

ASSESSMENT ACTIVITY

 Have the students click the start button below to complete an interactive quiz on the FOMC Lesson. Answers are below.



Have the students complete the following questions for a writing assignment:

 

  1. What are the Federal Reserve current observations and concerns? [The FOMC believes that the economy is growing too slowly or not at all. Although there is some inflationary pressure, concern about slow growth and unemployment prompted another federal funds rate cut in April.]
     
  2. What tool will the Federal Reserve use to accomplish its goals? [The Federal Reserve will seek to stimulate the economy by purchasing bonds. The Board of Governors has also reduced the discount rate. Another option is to reduce reserve requirements, although this is rare. Using open market operations is, by far, the more common policy tool in recent times.]
     
  3. If, in the coming months, the Federal Reserve were to become less concerned about the slow growth of the economy, what is it likely to do? [The Federal Reserve can either keep the federal funds rate the same or increase it if growth is picking up and there are more signs of increased inflation.]
     
  4. How do changes in monetary policy affect your family's spending and business spending in the economy? [If the Federal Reserve is buying bonds, banks will have more reserves/ With the increased excess reserves, banks will can increase the number and/or size of loans. The increase in loanable funds and the resulting lower interest rates encourage business and consumer borrowing and spending. The increased spending in the economy may result in inflationary pressures.]

CONCLUSION

Review:

  • The Federal Open Market Committee decided to lower its target for the federal funds rate by 1/4 percent (25 basis-points) on April 30, 2008. This reduced the target for the federal funds rate to 2 percent.
  • The primary reasons for the reduction were slow growth, increased unemployment and lack of adequate liquidity in the banking system.
  • The Federal Reserve can use its monetary tools, primarily open market operations to increase bank reserves, and thus, bank loans, spending and investment.
  • The FOMC must carefully watch for signs of inflation when determining how or if to stimulate the economy. Too much infusion of money into the economy can be inflationary.

EXTENSION ACTIVITY

Discussion: You are a member of the FOMC. Given the following scenario, what will you look for and consider in the coming weeks to determine what action, if any, to take at the next FOMC meeting?

Scenario: Growth continues to be slow, at an annualized rate of less than 1 percent. Inflation increased slightly in the last month to 4 percent. Unemployment was 4.6 percent in the last month. Several large banks reported slight increases in the number of loan defaults.

[Answers:

  • If growth continues to slow, the federal funds rate can be further reduced.
  • If the growth rate increases, the current rate can be retained.
  • If growth picks up and inflation is a fear, the federal funds rate can be kept the same or increased.
  • If unemployment increases, a policy to stimulate the economy can be used to increase employment.
  • If conditions are uncertain, the FOMC can take no action.
  • If the credit markets remain stagnant, lower interest rates can provide more liquidity and increase lending.
  • The pros and cons of these options seem to revolve around the competing goals of stimulating growth and reducing inflation.]