The Federal Open Market Committee decided today to keep its target for the federal funds rate unchanged at 1-1/4 percent.


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

Current Key Economic Indicators

as of November 30, -0001


The Federal Open Market Committee decided today to keep its target for the federal funds rate unchanged at 1-1/4 percent.

Oil price premiums and other aspects of geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses. However, the Committee believes that as those risks lift, as most analysts expect, the accommodative stance of monetary policy, coupled with ongoing growth in productivity, will provide support to an improving economic climate over time.

In these circumstances, the Committee believes that, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are balanced with respect to the prospects for both goals for the foreseeable future.

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

This complete press release is available at:

Reasons For A Case Study On The Federal Reserve Open Market Committee

Following recent Federal Open Market Committee announcements, newspapers across the country have had front-page stories about the Federal Reserve actions to target interest rates and boost spending and employment in the U.S. economy. Attention increased as the economy entered a recession beginning in March of 2001 and real gross domestic product (GDP) actually fell in the first three quarters of 2001. Concern has continued as the economy grew slowly in the second and fourth quarters of 2002. The announcements reflect serious concerns with the state and direction of the economy. While most economists believe the recession is now over, the economy is still in a fragile state and has not returned to the strength of years past.

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

Notes to Teachers

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

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

Guide To Announcement

From January 3 to December 11 of 2001, the Federal Reserve Open Market Committee (FOMC) lowered the target federal funds rate 11 times from 6.50 percent to 1.75 percent (a total reduction of 4.75 percent). That was the lowest target federal funds rate in forty years. At all 2002 meetings before the cut at the November meeting, the FOMC decided to leave the federal funds rate unchanged.

The first paragraph of the announcement summarizes the current monetary policy changes - this month it is the decision to leave the target federal funds rate unchanged The Federal Reserve Board of Governors also sets the discount rate, through a technical process of approving requests of the twelve Federal Reserve Banks. The discount rate also was left unchanged at this meeting and is not mentioned in the announcement when there are no changes.

In the second and third paragraphs, the Federal Reserve discusses the reasoning behind their decision. The statement that “the accommodative stance of monetary policy, coupled with ongoing growth in productivity, will provide support to an improving economic climate over time” shows that the Fed views current policy as proving effective. With that said, the Fed also shows it is sensitive to current world events by mentioning “oil price premiums and other aspects of geopolitical risk”, though the Fed concludes that these risks will eventually lift. In the third paragraph the Fed indicates that the risks are balanced between inflation (“price stability”) and sustainable growth, showing that the Fed is taking care to avoid overheating the economy in the quest to boost growth. The FOMC indicates that the long-run prospects are good. Current monetary policy is - meaning it should encourage economic expansion while containing inflation and not assisting a return to full strength too quickly. The FOMC members expect positive continued productivity growth. The fourth paragraph describes the votes of the FOMC members on changing the target federal funds rate. In the past, there has been a lag between the announcement and the publication of this information in the minutes. This change, which was implemented at the March 2002 meeting, is one step in a FOMC trend toward releasing more information immediately following their meetings. All members of the FOMC voted to leave the target federal funds rate unchanged.

There has been much recent debate about whether the Federal Reserve should lower rates further and risk inflationary pressures. In the press release, the Fed expresses no concern with potential inflationary pressures. The latest unemployment rate of 6.0% was a nine-year high and shows that weakness persists in the economy. In the absence of evidence of further slowing in the economy, the decision of the Fed will be scrutinized if inflationary aspects return to the economy in the near future as well as if unemployment does not begin to return to lower levels. In either case, there will be pressure on the Fed to act decisively.

The Target Federal Funds Rate and the Discount Rate


Data Trends

During the last half of the 1990s, real GDP grew at rates more rapid than those in the first half of the decade. That growth began to slow at the end of 2000. Real GDP increased at annual rates of 4.1 percent and 3.8 percent in 1999 and 2000. During the first three quarters of 2001, real GDP actually decreased. For the year as a whole, real GDP increased only by .3 percent. The slowing growth over the last two quarters of 2000 and the first three quarters of 2001 was one indication of the need to use a monetary policy that would boost spending in the economy. The FOMC responded by cutting the target federal funds rate throughout the year as noted above. Real GDP increased at an annual rate of 2.4 percent during 2002, with an extremely slow rate of increase in the most recent quarter of .7 percent. (For more on changes in the rate of growth of real GDP and the current recession, see the most recent GDP Case Study.)

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


On November 26, 2001, the National Bureau of Economic Research (NBER) announced though its Business Cycle Dating Committee that it had determined that a peak in business activity occurred in March of 2001. That signals the official beginning to a recession.

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

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

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

Many observers are now stating that the 2001 recession may have ended in December of 2001. The National Bureau of Economic Research has not yet declared the end of the recession.

For the full press release from the National Bureau of Economic Research see:

How does Monetary Policy Work?

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 December 10.) The seven Governors of the Federal Reserve Board and five of the twelve Presidents of the Federal Reserve Banks make up the committee. Governors are appointed by the U.S. President and confirmed by the U.S. Senate. The Boards of each Federal Reserve Bank select the presidents of the banks.

How does Monetary Policy Work?

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

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

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

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

Comparison of Monetary and Fiscal Policy

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

Fiscal policy, the taxing and spending policies of the federal government, also has the potential to influence economic conditions. Throughout this year, there have been debates in Congress about what to do with spending and taxes in order to stimulate overall spending in the economy. These debates continue and little has been accomplished. This points to one of the key differences between fiscal and monetary policy. Fiscal policy is much more difficult to implement but takes effect more rapidly once the decision is made. Monetary policy decisions are much easier to institute and more responsive to economic conditions, but take longer to have an effect on spending in the economy.

Creation of the Federal Open Market Committee

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 unexpired 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, for four-year terms.

Only one member of the Board may be selected from any one of the twelve Federal Reserve Districts. In making appointments, the President is directed by law to select a "fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country." These aspects of selection are intended to ensure representation of regional interests and the interests of various sectors of the public.

The seven Board members constitute a majority of the 12-member Federal Open Market Committee (FOMC), the group that makes the key decisions affecting the cost and availability of money and credit in the economy. The other five members of the FOMC are Reserve Bank presidents, one of whom is the president of the Federal Reserve Bank of New York. The other Bank presidents serve one-year terms on a rotating basis. By statute the FOMC determines its own organization, and by tradition it elects the Chairman of the Board of Governors as its Chairman and the President of the New York Bank as its Vice Chairman.
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How long does it take monetary policy to have an effect on the economy?

[Businesses and consumers do not normally change their spending plans immediately upon an interest rate change. Businesses must reevaluate, make new decisions and order reductions or expansions in production and expenditures. This means that months pass before spending is affected. Monetary policy typically has a short policy lag (the time it takes to create and implement policy) and a long expenditure lag (the time it takes businesses and consumers to adjust to the new interest rates). The total lag time is usually 9-12 months and varies a good bit. Thus when the Federal Reserve changes interest rates, their decisions will affect economic conditions in approximately a year from the time of the change.

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.]


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

    [While the Federal Reserve is optimistic about future conditions, there still is concern that economic conditions are not rapidly improving]
  2. What tools can the Federal Reserve use?

    [The Federal Reserve can buy or sell bonds, which in turn lower or increase the federal funds rate. The Federal Reserve can also change reserve requirements and the discount rate.]
  3. If the Federal Reserve is concerned about lack of economic expansion, what is it likely to do with its open market operations and the federal funds rate?

    [The Federal Reserve would purchase bonds to expand the money supply and reserves and lower the target federal funds rate.]
  4. If the Federal Reserve is concerned about lack of economic expansion and decided to use changes in reserve requirement and the discount rate, what would it do?

    [The Federal Reserve would lower reserve requirements and decrease the discount rate.]
  5. How do changes in monetary policy affect spending in the economy?

    [If banks have fewer reserves, they cannot make as many loans. The reduction in loans and the resulting higher interest rates discourage business (and consumer) borrowing and spending. In the case of too little growth or a reduction in spending, the increased availability of loans and lower interest rates may encourage businesses and consumers to increase their spending.]

  6. (More advanced) What are some "geopolitical risks" that could influence future economic conditions? How would economic conditions be affected?

    [Geopolitical risks include events such as a future terrorist attack or a war with Iraq. Related risks include actions such as higher oil prices, as well as a reduction in consumer confidence and spending. If consumers become nervous about future economic and political conditions, some may reduce spending leading to a falling real GDP and rising unemployment.]