South-Western College Publishing - Economics  
How Near Is Inflation?
Subject Federal Funds Rate
Topic Monetary Policy
Key Words

Inflation, Federal Funds Rate, and Monetary Policy

News Story

For a year now, the federal funds rate has remained at 1 percent, the lowest level since 1958. However, given recent reports citing increased hiring in the economy and workers' increased purchasing power that goes along with the new jobs, some analyst are pointing a finger towards impending inflation. Statisticians have also reported recent jumps in consumer prices, adding fuel to the fire. If these analysts are correct, the expected response of the Fed would be to increase the federal funds rate.

The Fed, however, paints a different picture. "The recent pickup in price increases probably does not represent the leading edge of steadily worsening inflation," said Donald Kohn, a Federal Reserve Board governor. Kohn went on to say that the surge in commodity prices are not a new trend, but consistent with "effective price stability."

Other Fed officials, including Chairman Greenspan, are also going out of their way to tell a similar story, arguing that inflation is likely to remain under control for the near future. "I am not dismissing the risk of an unwelcome further increase in inflation," said Alfred Broaddus, president of the Federal Reserve Bank of Richmond, Virginia. "I think the risk is manageable," he added.

Mr. Greenspan argues that even if total wages do climb as firms hire more labor, those companies will initially absorb the increased costs rather than take the chance of losing market share.

The Fed normally holds eight monetary policy meetings each year, and regardless of the slow and easy stance taken by the Fed, most analysts predict a rise in the federal funds rate will be needed soon at one of these meetings. The increase will be necessary to combat the potential rise in prices and the harmful effect inflation will have on the economy.


(Updated August, 2004)

Questions
1.

Define inflation and note its effects on commodity prices, manufacturing firms, service-based companies, and on individuals..

2. Discuss the economic impact of raising the federal funds rate. How is the federal funds rate set?
3. Discuss the harmful effect of inflation. Does inflation provide any benefits to anyone?
Source Edmund Andrews, "Fed Officials Seek to Ease Fears of a Surge in Inflation" New York Times Online, June 8, 2004.

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