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This lesson focuses on the December 13, 2011, press release by the Federal Reserve System's Federal Open Market Committee (FOMC) on the current Federal Reserve monetary policy goals and actions, and specifically, the target for the federal funds rate. 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 December 13, 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 target federal funds rate 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 a long period of low and sometimes negative real GDP growth, significant non-farm employment losses and a persistently high unemployment rate.

This lesson focuses on the December 13, 2011, press release by the Federal Open Market Committee on the current Federal Reserve monetary policy goals and actions.

[Note to teacher: In the first semester of the 2011-2012 school year (September-December), 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.

This lesson about the December 13, 2011, FOMC meeting, will address more specific issues of Fed policy tools, policy options, and new Fed programs to counter recessionary pressures and the current financial market problems.]

[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.]

To learn more about the Federal Open Market Committee, its membership, meeting schedule, and responsibilities, go to: http://www.federalreserve.gov/monetarypolicy/fomc.htm.

MATERIALS


Key Economic Indicators

as of December 13, 2011

Inflation

On a seasonally adjusted basis, the CPI-U decreased 0.1 percent in October after increasing 0.3 percent in September. The index for all items less food and energy rose 0.1 percent in October, the same increase as in September.

Employment and Unemployment

The unemployment rate fell by 0.4 percentage point to 8.6 percent in November, and nonfarm payroll employment rose by 120,000. Employment continued to trend up in retail trade, leisure and hospitality, professional and business services, and health care. Government employment continued to trend down.

Real GDP

Real gross domestic product increased at an annual rate of 2.0 percent in the third quarter of 2011 (that is, from the second quarter to the third quarter) according to the "second" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 1.3 percent.

Federal Reserve

The Federal Open Market Committee 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.

PROCESS

December, 2011, marks three significant anniversaries related to the current U.S. business cycle.

  • In December, 2007, the most recent U.S. recession began.  The recession ended in June, 2009, but the business cycle trough was not identified until September, 2010.
  • On December 1, 2008, The National Bureau of Economic Research (NBER) declared that the U.S. economy reached a peak in the business cycle in December, 2007, and the most recent recession began. This announcement was made a full year after the recession began.
  • At its December 8, 2008, meeting, the Federal Open Market Committee established a new target for the federal funds rate, at a range of 0 to 1/4 percent.  This historically low fed funds rate target has been maintained at this level to this date.

[Teacher Note: The Business Cycle Dating Committee of the National Bureau of Economic Research is charged with identifying the peaks (beginning of a recessions) and the troughs (end of a recession) of the business cycles.  For more information, go to: ' ]

What did the FOMC have to say, three years after pushing it's primary tool to reduce interest rates and stimulate credit markets - the federal funds rate - to it's low limit?

The Federal Reserve's Monetary Policy Goals

Remember, the national monetary policy goals of the Federal Reserve, as established by the federal Employment Act of 1946, are to "promote maximum employment, production, and purchasing power."

In other words, Fed and other government agencies should adopt policies to:

  • Create jobs - reduce the unemployment rate and increase employment.
  • Increase output - improve the real GDP growth rate.
  • Maintain stable purchasing power - keep the CPI increase at a low level.

[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).'  The 1946 law was amended in 1978 by the "Full Employment and Balanced Growth Act."  Link: http://research.stlouisfed.org/publications/review/article/2977 ]

"Monetary Policy" Statement

Federal Open Market Committee
Released: December 13, 2011

"Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth. While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but business fixed investment appears to be increasing less rapidly and the housing sector remains depressed. Inflation has moderated since earlier in the year, and longer-term inflation expectations have remained stable."

The typical monetary policy statement begins with an observation about the recent health or the growth trend of the economy. In this case, it was a moderate expansion - consistent with recent real GDP growth and employment increases.  The statement was more optimistic than past statements, but included some cautionary statements.

"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. Strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations."

Recent statements have referred to the Fed's mandate as explained in the beginning of this lesson - growth, stable prices and full employment.  The result of this meeting was no substantive policy change, with the Fed anticipating gradual improvement, despite the possibility of problems in global financial markets.  As with other recent statements, there was a mention of the potential for inflation in the longer  term.

[Teacher Note:  Ask your students if they see any signs of inflation. Remind them of the volatility of gasoline prices which have increased and decreased almost monthly, and that this may not be a sign of inflation - an increase in the general price level.]

"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."

There was no change in the additional Fed policies adopted at recent meetings, to extend the average maturity of its securities, improve bank liquidity, and encourage lending.  The Fed website explains: "Under the maturity extension program, the Federal Reserve intends to sell $400 billion of shorter-term Treasury securities by the end of June 2012 and use the proceeds to buy longer-term Treasury securities. This will extend the average maturity of the securities in the Federal Reserve’s portfolio."

"By reducing the supply of longer-term Treasury securities in the market, this action should put downward pressure on longer-term interest rates, including rates on financial assets that investors consider to be close substitutes for longer-term Treasury securities. The reduction in longer-term interest rates, in turn, will contribute to a broad easing in financial market conditions that will provide additional stimulus to support the economic recovery." http://www.federalreserve.gov/monetarypolicy/maturityextensionprogram.htm

"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 federal funds rate target will remain at 0 to 1/4 percent as long as current economic conditions remain and inflation is not anticipated.  Remember, the FOMC's target rate of 0 to 1/4 percent has been in effect since 2008.  See Figure 1, below.

"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."

Is this good news or bad news?  Are the slightly lower (6.8 percent) unemployment rate in November and 2 percent real GDP growth in Q3 of 2011 signs of the improved health of the U.S. economy?   Figure 1, below, shows the recent history of the federal funds rate target.

Figure 1

[Teacher Note:  Students can compare Figure 1, the fed funds rate targets, to Figures 2, 3, and 4 - the unemployment rate, real GDP growth rate, and productivity.  Are they related over time?  When the unemployment rate began to increase and GDP growth slowed in 2007, the Fed reduced the fed funds rate.  You can see the same pattern in periods of GDP growth and decline. Productivity has improved over the past several quarters, increasing output without additional hiring.]

The Federal Reserve uses monetary policy actions, such as open market operations - the buying and selling of government securities - to increase or decrease the money supply and bank lending activities to achieve the monetary policy goals of the Employment Act of 1946.  In a time of high unemployment and slow growth, an "accommodative" policy of low interest rates is intended to stimulate output and employment. In a time of high inflation, more restrictive policies - higher interest rates - may be used to slow economic activity.

How does the history of the federal funds rate relate to other recent economic data?

The Unemployment Rate

Figure 2, below, shows the recent history of the U.S. unemployment rate, reaching a recent low of 8.6 percent in November, 2011, after an extended period over 9 percent.

Figure 2

[Teacher Note:  Ask: How does the level of the fed funds rate target relate to the recent levels of unemployment?  As unemployment decreased, the FOMC reduced the fed funds rate to stimulate the economy and hiring.]

 

U.S. Real GDP Growth

Figure 3, below, shows the recent history of the U.S. real gross domestic product growth rate. Note the cycles that are similar to the unemployment rate changes over time.

Figure 3

[Teacher Note:  Ask: How does the level of the fed funds rate target relate to the recent levels of real GDP growth/decline?  As GDP slowed and decreased, the FOMC reduced the fed funds rate to stimulate the U.S. economy.]

Productivity

How can U.S. output be increasing and yet the unemployment rate remains high?  There are many factors influencing the growth and unemployment rates (size of the labor force, number marginal workers, etc.), but one key factor in the past year has been a significant increase in the rate of labor productivity - the amount of output per hour worked.

Look at the annual rates of productivity increases in recent years, below.    The BLS reported in November 30, 2011 that U.S. labor productivity increased at an annual rate of 2.3 percent in Q3 of 2011.

Figure 4: U.S. Annual Labor Productivity Change
Year Labor Productivity
Rate Change
2005 1.6%
2006 0.9%
2007 1.5%
2008 0.6%
2009 2.3%
2010 4.1%
2011 Q3 2.3%


Productivity and Costs, Third Quarter 2011, released November 30, 2011: http://www.bls.gov/news.release/prod2.nr0.htm

"Productivity rose 2.3 percent in the nonfarm business sector in the third quarter of 2011; unit labor costs decreased 2.5 percent (seasonally adjusted annual rates). In manufacturing, productivity grew 5.0 percent and unit labor costs fell 5.1 percent."

[Teacher Note: Ask: Is this a ''jobless recovery'?  The economy has grown recently without creating large numbers of jobs. Is this the result of improved productivity? Is this good or bad?]

International News

On Thursday, December 1, the European Central Bank (ECB) reduced its primary interest rate for the second time in recent months in order to stabilize the European banks and, possibly, prevent a recession. 

Weakness in European financial markets, largely as a result of sovereign debt and unstable banks, has negatively impacted U.S. markets, but the FOMC has not considered the European situation enough of a threat to take stronger domestic actions at this time, adopting the current policy, even though "Strains in global financial markets continue to pose significant downside risks to the economic outlook."

More Teacher Resources

Here are a few lessons from the Council for Economic Education (CEE) instructional materials that can be used to teach more about the Federal Reserve and monetary policy.  All of these publications are available through the CEE online publications store, http://store.councilforeconed.org/.   They are also on "Virtual Economics" version 4.

  • "Monetary Policy in the Recent Financial Crisis," Lesson 5, Teaching Financial Crises, 2010.
  • "The Federal Reserve and It's Tools," Lesson 4, Macroeconomics Unit, Advanced Placement Economics: Teacher Resource Manual, 3rd Edition, 2003.
  • "Money and Monetary Policy," Unit 6: Lesson 34, Capstone: Exemplary Lessons for High school Economics Teachers Guide, 2003.
  • "Money, Interest and Monetary Policy," Lesson 19, Focus: High school Economics, 2003.
  • Search EconEdLink for more lessons on the Federal Reserve and monetary policy, www.econedlink.org.

CONCLUSION

Once again, the FOMC's statement began, "Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth. While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but business fixed investment appears to be increasing less rapidly and the housing sector remains depressed. Inflation has moderated since earlier in the year, and longer-term inflation expectations have remained stable."

What more can the Federal Reserve, Congress, the President, or other government agencies do to get the economy moving at a faster pace and create jobs for the over fourteen million people who remain unemployed in the United States?

The Fed has kept the fed funds rate target historically low, influencing other rates to remain low - mortgage rates, consumer loans, auto loans, etc.  The Fed is purchasing securities to provide additional financial market liquidity.  

Interest rates are not the issue.  Uncertainty about the future and, perhaps, caution about global conditions and to not make the same mistakes may be keeping banks from lending, businesses from hiring and, consumers from purchasing.  

The Fed's policy statement provides some hope of improvement in growth of output and employment.  The recession over, but the impact remains and true recovery is slow?

Congress and President Obama seem to have agreed on a package of corporate and individual tax cut extensions, unemployment compensation extensions, and further stimulus policies to weather the storm, but at a very high price to be paid in the future. 

What more can the Fed do?

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.]

EXTENSION ACTIVITY

The Federal Reserve Bank of Philadelphia has published a new online activity called The Case of the Gigantic $100,000 Bill. . 

Thumbnail for version as of 20:29, 15 August 2007

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. 

[Teacher Note:  Use this Extension lesson to teach the concept of the money multiplier and how the federal Reserve "creates" money"  or changes the supply of money through monetary policy auctions.]