South-Western College Publishing - Economics  
, November 17, 1999.
For the Fed, Once Is Not Enough
Subject Interest Rates
Topic Monetary Policy
Key Words Interest rates, Monetary Policy, Unemployment, Economic Growth, Federal Funds Rate
News Story

Responding to the significant decline in the nation's pool of available workers who are not employed, the Federal Reserve raised short-term interest rates by one-quarter percent to 5.5 percent. Since many banks adjust their prime rate to the federal funds rate, the increase will make borrowing more costly to consumers and businesses, as rates on consumer borrowing, credit card balances and home equity loans follow the increase. The Fed expects that the increase will ease economic growth and reduce the demand for labor, as reductions in sales will cause businesses to cut production. The Fed also adopted a neutral stand in terms of the need for further reductions.

This rate hike had been widely anticipated. At last month's meeting of the Federal Reserve Open Market Committee, the committee said that it was leaning toward an additional rate increase. Although there is some evidence that some sectors of the economy, housing and auto sales, in particular, are already slowing, and there is little evidence of wage inflation, this month's labor market report reinforced the Fed's worries. The nation's unemployment rate had fallen to 4.1 percent in October, the lowest level since January 1970. Economic growth, the Committee concluded, must be slowed in order to prevent the tightness in the labor market from generating inflation.

Since late June, the Fed has increased its federal funds rate three times. The Fed also increased the discount rate to 5 percent from 4.75 percent. Additional rate increases in December are not likely because of concerns about the impact of the Y2K problem on the financial sector. The Fed's announcement did not preclude rate increases during the early part of next year.

(Updated January 1, 2000)

1. What is the composition of the Fed's Open Market Committee?
2. What is the Federal Funds rate? The Discount rate?
3. How does an increase in the Federal Funds rate result in a decrease in aggregate demand?
4. Besides increasing the Federal Funds rate, what other mechanisms are available to the Fed to reduce aggregate demand?
Source John M. Berry, "Federal Reserve Raises Key Rate," The Washington Post

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