South-Western College Publishing - Economics  
Spend It While You Have It
Topic Consumer Spending and Inflation
Key Words Consumer Spending, Inflation, and Monetary Policy
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Reference ID: A150713024

News Story Rising personal income and strong consumer spending numbers for July suggest that the American economy is not slowing as much as some analysts had suggested. The Commerce Department reported recently that total American consumer personal spending rose 0.8 percent in July, twice as fast as in June and the sharpest increase since January 2006.

Economists explain this increased spending as increased demand for consumer goods--which may increase overall prices throughout the economy. The Federal Reserve, the watchdog for inflation in the economy, uses the core inflation index, which excludes volatile food and energy prices, as they look at the overall price level throughout the economy. Even though consumer spending was high, the core index of inflation increased only 0.1 percent in July--the smallest increase this year. This is good news to the Fed. Fed Chairman Ben S. Bernanke continues to predict that the economic expansion will slow without stalling and come to the "soft landing" that Fed officials are hoping for.

However, analysts still find plenty of room for worry. The core index was still 2.4 percent higher than a year earlier and Fed policy makers consider a 2 percent annual inflation to be at the high end of what they think the economy can tolerate without starting an inflationary spiral. Normally, the Fed will tighten monetary policy when the core rate is above 2 percent. The Fed has indicated that they may be forced to quickly resume interest rate increases if any signs appear that overall price levels are on the rise.

In the August 8 meeting of the Federal Open Market Committee (FOMC), members voted to leave interest rates unchanged at 5.25 percent. But according to the minutes of the meeting, some members expressed concern that inflation was still running high. The committee said its decision to hold the Federal Funds rate steady was "a close call," and warned that "additional firming could well be needed"-meaning that another rate increase could still be in the offing.

Discussion Questions:
1. Use any source to look up what economic concerns dominated the U.S. news in August, 2006. Did you find any information that might suggest why the Fed went easy on interest rates beyond what's mentioned in the above article?
2. Discuss the notion of a tight monetary policy.
Multiple Choice/True False Questions:
1. The core inflation index excludes:
  1. clothing prices.
  2. food and energy prices.
  3. transportation.
  4. recreation.
2. The Fed's policy making committee is the:
  1. Consumer Relations Committee.
  2. National Food and Energy Committee.
  3. Federal Open Market Committee.
  4. Core Inflation Committee.
Source Jeremy Peters, "Consumer Spending in July Grew at Twice the June Rate", The New York Times Online, September 1, 2006.
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