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 target federal funds rate at a range of zero to 1/4 percent since its December 16, 2008 meeting. The fed funds rate has been kept at this historically low level due to a long period of low and often negative real GDP growth, record numbers of non-farm employment losses, and a persistently high unemployment rate.
This lesson focuses on the November 2, 2011, press release by the Federal Open Market Committee on the current Federal Reserve monetary policy actions and goals.
- Explain the meaning of the November 2, 2010, Federal Open Market Committee decision concerning the target for the federal funds rate and other monetary policy actions.
- Identify the current monetary policy goals of the Federal Reserve and the factors that have recently influenced monetary policy goals.
- Explain the structure and functions of the Federal Reserve System, Federal Reserve Banks, and the Federal Open Market Committee.
- Identify the monetary policy options and other tools available to the Federal Reserve to stimulate or contract the economy.
If the primary monetary policy tool of the Federal Reserve is open market operations - the buying and selling of government securities to influence the money supply and interest rates - it poses a critical question:
Does the Federal Reserve have any real power to stimulate the economy today?
The Federal Open Market Committee (FOMC) of the Federal Reserve System has maintained the target for the federal funds rate at a range of zero to 1/4 percent since December 16, 2008. This historically low fed funds target has been intended to provide the liquidity and low interest rates to stimulate the economy since the beginning of the 2008-2009 recession.
Since that time, the FOMC has kept the federal funds rate very low and has provided additional stabilization and stimulus through a variety of programs intended to improve the balance sheets of banks and liquidity in credit markets. The Fed has purchased hundreds of billions of dollars of securities through "quantitative easing" programs referred to as "QE," and more recently, a second round, commonly referred to as "QE2."
If the federal funds rate is, practically speaking, as low as it can go, what can the Fed do? At its most recent meeting, the FOMC reiterated its commitment to economic stimulus.
Students: Should the Federal Reserve actively work to stimulate the economy? Some say "yes" and some say "no." What do you think?
Board of Governors of the Federal Reserve System
Federal Open Market Committee
Monetary Policy Press Release
November 2, 2011
"Information received since the Federal Open Market Committee met in September indicates that economic growth strengthened somewhat in the third quarter, reflecting in part a reversal of the temporary factors that had weighed on growth earlier in the year. Nonetheless, recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has increased at a somewhat faster pace in recent months. Business investment in equipment and software has continued to expand, but investment in nonresidential structures is still weak, and the housing sector remains depressed. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable."
Good News! The FOMC characterized the economy as "...economic growth strengthened somewhat..." Spending is up in all sectors. The bad news, "the unemployment rate remains elevated." More good news: there seems to less fear of inflation.
"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations."
Remember, the monetary policy goals of the Federal Reserve, as mandated in the Employment Act of 1946, are to promote economic growth, full employment, and price stability. The FOMC's comments on prospects of inflation recognize the potential for inflation as a result of more stimulatory monetary policies.
Students: To read abouthe Employment Act of 1946, go to: research.stlouisfed.org/publications/review/86/11/Employment_Nov1986.pdf
"To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies 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. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."
As a result, the FOMC confirmed that the strategy of lengthening the average maturities of the Fed's securities holding will continue. This strategy - the twist - was announced after the FOMC's August meeting. And again, there will be no change in the target rate for the federal funds rate.
"The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."
The FOMC commented that the economy remains slow and not able to use its productive resources - primarily labor resources - to grow.
Figure 1, below, shows the recent history of the FOMC's target for the federal funds rate. Notice the 0 -.25 percent target since December of 2008. Previous to that time, rates had risen and fallen as the FOMC responded to growth and/or inflation issues.
Students: Can you see the historical "business cycles" and the movements of the federal funds rate target?
"The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability."
On Wednesday, November 2, 2011, Mario Draghi, president of the European Central Bank (ECB) announced that the ECB will lower it's "benchmark interest rate" by .25 percent to 1.25 percent. This action was in response to the threat of a new European recession and the continuing sovereign debt crisis in Europe. This was a significant action, since the ECB has consistently viewed inflation as a primary reason to keep interest rates higher. Lowering interest rates in order to promote stability and growth is a reversal of past ECB monetary policy goals.
One of the issues impacting U.S. banks and contributing to the uncertainty of our economy is the European debt crisis. This is evidence of the growing interconnectedness of the global economy. The FOMC announcement cites "strains in global financial markets" as a contributing factor to the uncertainty in U.S. markets. A more accommodative monetary policy in Europe may be a positive sign for U.S. growth prospects.
Studnets: What the Fed should do. Or, what else can they do, since the federal funds rate is so low? Can the Fed directly help to create jobs? Should the Fed have the power to force banks to make more loans that create jobs?
The Federal Funds Rate
Targeting the federal funds rate has been the primary policy of the FOMC in recent years. Remember, the federal funds target rate is the interest rate at which depository institutions (banks, etc.) lend balances (excess reserves) at the Federal Reserve to other depository institutions overnight. The purpose of these overnight loans is to allow depository institutions to meet their reserve requirements.
Banks use their reserves to generate loans. Loans facilitate investment and consumption. The lower the cost of the loans, the more investment and consumption - in theory. In this recovery, low interest rates have not been enough to generate jobs and growth, so the Fed has turned to more direct actions.
If a bank makes a loan, its reserves decrease. If the bank’s reserve ratio drops below the minimum required by the Fed, it must add to its reserves. The bank can borrow reserves from another bank that has a surplus of reserves in its account with the Fed. The interest rate the borrowing bank pays to the lending bank is negotiated between the two banks. The weighted average of all of these negotiated rates is the federal funds effective rate. The FOMC sets a target rate or target range, and uses open market operations to influence bank reserves and the determination of the effective rate.
In this recovery, low interest rates have not been enough to generate sufficient jobs and growth, so the Fed has turned to more direct actions.
Open Market Operations
Open market operations are the Federal Reserve's primary tool for implementing monetary policy. The Fed web page briefly explains the objective of open market operations. "Open market operations--purchases and sales of U.S. Treasury and federal agency securities--are the Federal Reserve's principal tool for implementing monetary policy. The short-term objective for open market operations is specified by the Federal Open Market Committee (FOMC). This objective can be a desired quantity of reserves or a desired price (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 objective for open market operations has varied over the years. "During the 1980s, the focus gradually shifted toward attaining a specified level of the federal funds rate, a process that was largely complete by the end of the decade. Beginning in 1994, the FOMC began announcing changes in its policy stance, and in 1995 it began to explicitly state its target level for the federal funds rate. Since February 2000, the statement issued by the FOMC shortly after each of its meetings usually has included the Committee's assessment of the risks to the attainment of its long-run goals of price stability and sustainable economic growth.” Source: Open Market Operations
With the target range for the federal funds rate currently at such a low level (0 to 1/4 percent) and the real rate exceptionally low, there is not much potential for use of the typical monetary policy tools to stimulate growth. The Fed has made unprecedented efforts to stabilize credit markets, improve liquidity and encourage lending.
The target federal funds rate set by FOMC is maintained through open market operations. By purchasing or selling securities, the Fed can influence the level of bank reserves, and thus, the level of the federal funds rate. The FOMC will increase or decrease the target rate depending on economic conditions and the Fed’s overall monetary policy goals. The Fed doesn’t actually set the rate, but can influence the rate through open market operations. When a bank buys securities, from the Fed, it then has fewer funds to loan. When a bank sells securities to the Fed, it then has more funds (reserves) to loan.
An alternative for banks that must increase their reserves is to borrow directly from the Federal Reserve through the “discount window.” The discount rate is typically slightly higher than the federal funds rate. The FOMC will typically change the discount rate as it establishes a target for the federal funds rate.
Students: How important is it that the Federal Reserve has independent power to implement monetary policies to maintain a stable price level, promote employment growth, and stimulate growth in the economy?
What happens at a FOMC meeting?
About three weeks after each FOMC meeting, the minutes of the meeting are released. The minutes provide more information about how the meeting’s policy statement was determined and additional factors that were considered. It often provides a more clear indication of future policy options.
Minutes of the Federal Open Market Committee, September 20-21, 2011
"A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal Reserve System was held in the offices of the Board of Governors in Washington, D.C., on Tuesday, September 20, 2011, at 10:30 a.m., and continued on Wednesday, September 21, 2011, at 9:00 a.m."
The minutes list the members of the FOMC and all others who were present of the discussion. In this instance, eleven FOMC Committee members were present along with fifty others, representing various Federal Reserve Banks, FRB staff and key operations persons. The new members of the FOMC were officially elected. The meeting was chaired by Ben S. Bernanke, Chairman of the Federal Reserve.
The minutes summarize the discussion of the FOMC members and the staff on current financial and economic conditions, and future outlook. Read the minutes of the September 21-22, 2011, FOMC meeting, go to: www.federalreserve.gov/monetarypolicy/fomcminutes20110921.htm
At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the System Account in accordance with the following domestic policy directive:
"The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range from 0 to 1/4 percent. The Committee directs the Desk to purchase, by the end of June 2012, Treasury securities with remaining maturities of approximately 6 years to 30 years with a total face value of $400 billion, and to sell Treasury securities with remaining maturities of 3 years or less with a total face value of $400 billion. The Committee also directs the Desk to maintain its existing policy of rolling over maturing Treasury securities into new issues and to reinvest principal payments on all agency debt and agency mortgage-backed securities in the System Open Market Account in agency mortgage-backed securities in order to maintain the total face value of domestic securities at approximately $2.6 trillion. The Committee directs the Desk to engage in dollar roll transactions as necessary to facilitate settlement of the Federal Reserve's agency MBS transactions. The System Open Market Account Manager and the Secretary will keep the Committee informed of ongoing developments regarding the System's balance sheet that could affect the attainment over time of the Committee's objectives of maximum employment and price stability."
In the end, the FOMC agreed on the statement quoted at the begriming of the October FOMC lesson. This is the press release: "Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable."
Was the FOMC more or less optimism in November
In recent times, each FOMC statement has begun with just about the same line, “Information received since the Federal Open Market Committee met in (referencing the date of the previous meeting)." This opening provides the basic rationale for the meeting decision. The November 2, 2011, statement began, “Information received since the Federal Open Market Committee met in September indicates that economic growth strengthened somewhat in the third quarter, reflecting in part a reversal of the temporary factors that had weighed on growth earlier in the year.” This was the most optimistic sounding introduction in recent times.
Here’s a history of this key FOMC language over the last year:
- November 3, 2010: “the pace of recovery in output and employment continues to be slow.”
- December 14, 2010: “the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.”
- January 26, 2011: “the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions.”
- March 15, 2011: “the economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually.”
- April 27, 2011: "the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually."
- June 22, 2011: "the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.
- August 9, 2011: "economic growth so far this year has been considerably slower than the Committee had expected."
- September 21, 2011: "economic growth remains slow."
- November 2, 2011: "economic growth strengthened somewhat in the third quarter."
Notice how the language has changed from meeting to meeting - mostly vague assessments. The previous months' statements have been somewhat more negative. In November, the language turned slightly more optimistic, using the term "strengthened somewhat."
Students: What does the FOMC mean by this kind of language? Is "strengthened somewhat" really positive? Can you identify some of the economic data the FOMC might have used to make this statement?
The November 2, 2011, FOMC monetary policy statement confirmed what many economists, analysts and news commentators expected - no change in the federal funds rate target and a continuation of the recently announced stimulus programs.
Again, the FOMC decided that low interest rates have not been enough to stimulate economic activity, and that the "twist" program to lengthen the average maturity of securities holdings.
Instability in international financial markets - most notably Greece and Italy - have weighed heavily on U.S. markets and the economy. Uncertainty has caused people, businesses and governments to be more cautious. The FOMC noted that investment in both residential and nonresidential structures remains week. Investment is an indicator of people's and businesses' view of the future.
Is this FOMC statement good news or not?
Next, answer the essay question on the interactive notepad.
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, the level of loanable funds, and economic activity.]
The Federal Reserve has published an Internet-based educational resource for teachers and students called "Federal Reserve Education
Federal Reserve Education includes sections on the history of the Fed, the structure of the Fed, monetary policy, bank supervision, and financial services.
- The above link will take you to the section on "Monetary Policy." Review the "Basics of Monetary Policy."
- Click on "How does the Fed create money?" to learn how Fed actions can influence the money supply.
- Click on "Economic Indicators" to review the meaning of gross domestic product, consumer price index, unemployment rate and other economic indicators.
This will help you better understand the monetary policy goals and actions of the Fed in the context of economic conditions, such as those discussed at the FOMC meetings.
Federal Reserve Education includes a link to a web page that lists a variety of economic data sources (www.forexhound.com/article/Central_Banks/Fed_Background/Economic_Indicators_By_the_Numbers/69850 , www.federalreserveeducation.org/resources/economic_indicators/ ) and additional links to the current data for each indicator.
To find information about your Federal Reserve System district reserve bank, go to: www.federalreserveeducation.org/about-the-fed/ and click on your region on the map.
Students: Find your school's Federal Reserve District. What going on in your area?