South-Western College Publishing - Economics  
A Delicate Balance
Subject Employment, Unemployment, and Inflation; Productivity and Growth
Topic Monetary Policy
Key Words Inflation, Interest Rates, Open Market Committee, Monetary Policy
News Story

For the past few months, people who watch the actions of the Federal Reserve were looking for an increase in interest rates because of concern that the economy was growing too rapidly. The result of each meeting of the Federal Reserve's Open Market Committee was to keep interest rates constant, but the feeling was that it was only a matter of time before rates would have to be increased. The Fed's Open Market Committee met and again held interest rates in check but this time the motivation for their action was different. The Fed was trying to balance the needs of a domestic economy displaying strength and an increasingly fragile global financial market.

When Fed Chairman Alan Greenspan testified before Congress recently, he stated that monetary policy was stable because the economy was showing solid, yet moderating growth and low inflation. Mr. Greenspan also stated that "significant risks attend the outlook." Economic conditions in Japan and Asia have deteriorated and have apparently spread to Russia. An increase in U.S. interest rates could produce an inflow of capital weakening financial markets overseas. A deepening of Asia's financial crisis could hurt U.S. markets by causing a significant drop in the stock market and cutting demand for U.S. exports. The U.S. trade deficit in June remains very large according to yesterday's Commerce Department report.

With unemployment at historic lows, inflation still in check, and consumer spending strong, there is the fear that inflation could start to take off. This would push the Federal Reserve to raise interest rates. However, global forces are pushing in the opposite direction. These global forces are becoming increasingly strong and argue for no increase in interest rates. The Fed will have to balance these competing forces when considering its monetary policy. (Updated September 1, 1998)
  1. What is monetary policy?
  2. What instruments does the Fed have available to implement monetary policy?
  3. What happens to aggregate demand when the Fed raises interest rates?
  4. What happens to real GDP and the price level when the Fed raises interest rates?
Source Jacob M. Schlesinger, "Fed, In Balancing Act, Leaves Rates Alone," The Wall Street Journal, August 19, 1998

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