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This lesson focuses on the April 27, 2011, 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.

KEY CONCEPTS

Central Banking System, Federal Reserve, Macroeconomic Indicators, Monetary Policy, Money Supply, Tools of the Federal Reserve

STUDENTS WILL

  • Explain the meaning of the April 27, 2011, 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 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

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 April 27, 2011, 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 2010-2011 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.]

MATERIALS


Key Economic Indicators

as of April 28, 2011

Inflation

On a seasonally adjusted basis, the CPI-U increased 0.5 percent in March, the same increase as in February. The index for all items less food and energy rose 0.1 percent in March after increasing 0.2 percent in February.

Employment and Unemployment

U.S. nonfarm payroll employment increased by 216,000 in March, and the unemployment rate was little changed at 8.8 percent. Job gains occurred in professional and business services, health care, leisure and hospitality, and mining. Employment in manufacturing continued to trend up.

Real GDP

U.S. real GDP increased at an annual rate of 1.8 percent in the first quarter of 2011 (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 3.1 percent.

Federal Reserve

The FOMC will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

PROCESS

First, a Little Recent History Review:

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 recession had ended.

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What did the FOMC have to say, more than two 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: April 27, 2011

The FOMC announced, "Information received since the Federal Open Market Committee met in March indicates that the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually."

The FOMC cited these highlights, "Household spending and business investment in equipment and software continue to expand.  However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed.  Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the Committee met in March."

What about inflation?  The FOMC added, "Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued."

The FOMC then commented on its progress toward achieving its macroeconomic goals - fostering maximum employment and maintaining price stability.  "The unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.  Increases in the prices of energy and other commodities have pushed up inflation in recent months."

What does the FOMC expect in the near future? "The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations.  The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability."

"To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.  In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter.  The Committee will regularly review the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability."

[Teacher Note:  The Federal Reserve Board of Governors has produced an online video program explaining the program of  "Large Scale Asset Purchases" and monetary policy.
' ]

The FOMC federal funds rate action was to "maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period."

The FOMC announcement conclusion, "The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate."

What Will the Fed Look For? 

Figure 1, below, shows the recent history of U.S. real growth of gross domestic product (GDP).

Figure 1

Figure 2, below, shows the recent history of monthly U.S. unemployment rates.

Figure 2

U.S. output is increasing, although at a slower rate than in 2010.  The U.S. unemployment rate remains very high.  Look again at Figures 1 and 2, specifically at 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, will end in June, 2011.

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.

Figure 3

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.

Are you worried about inflation?

[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.

Recent History of the Federal Funds Rate

At it's April 27, 2011 meeting the FOMC decided to keep the target for the federal funds rate at the same level that was first established in December, 2008.  Figure 4, below, shows the history of the federal funds rate from 1990 to the present.  Note the periodic increases and decreases, as the FOMC has  sought to influence interest rates to rise and fall in order to reduce inflationary pressures, stimulate growth, or just to keep the price level stable.

Figure 4

[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:  http://www.federalreserveeducation.org/resources/detail.cfm?r_id=53368c4c%2Dc844%2D43c7%2Da904%2D7b92bbd15619 ]

ASSESSMENT ACTIVITY

Essay Question:

1.  What is the purpose of the FOMC's target for the federal funds rate?

[The FOMC sets the target federal funds rate in order to influence interest rates and to expand or contract the money supply. It is the "target"' or the goal of the Federal Reserve. To achieve the goal, the Federal Reserve Bank of New York Trading Desk will purchase or sell securities in order to influence bank reserves and lending. This, in turn, will stimulate or contract the money supply and economic activity.]

CONCLUSION

This FOMC monetary policy announcement began with a quick assessment of the current economic conditions as, "the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually."

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 was to "maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period."

The continuing question is "how long is the extended period?" 

In his first-ever press conference associated with a monetary policy announcement, Fed Chairman Ben Bernanke said that the Fed has revised downward  its growth estimate for 2011 to just over three percent and that the recovery was proceeding at a “moderate pace,” a step back from his characterization that it was on “firmer footing” in the previous month.  “The pace of improvement is still quite slow and we are digging ourselves out of a very, very deep hole,” Bernanke added.

The Fed revised its projection of inflation in 2011 inflation dues to higher oil prices. The projection for "core" inflation was increased just slightly.  Bernanke added that he did not think the oil price increases would cause more serious overall price level increases.

Bernanke reaffirmed that the Fed is ready to act if economic growth slows or if the threat of inflation worsens.

EXTENSION ACTIVITY

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. 

Go to: The Case of the Gigantic $100,000 Bill.

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."

Go to: The Economy: Crisis and Response