South-Western College Publishing - Economics  
Interest Rates Remain Unchanged
Subject Federal Reserve Interest Rate Policy
Topic Monetary Policy
Key Words

Short-term Interest Rates, Job Market, And Economic Stimulus

News Story

The Federal Reserve met in March and decided to leave short-term interest rates unchanged. This same scenario has been acted out many times in the recent past: The Fed seems content to keep the federal funds rate (the rate on overnight loans between banks) at its lowest level in 46 years.

Low interest rates stimulate economic activity and job growth. The Fed, in making its decision, noted that "hiring has lagged" and revealed concern over a weak job market, which may be stimulated by lower interest rates. All indications are that the Fed will refrain from raising rates until much later this year or perhaps even next year.

The Fed statement was slightly more pessimistic than last month in referring to the job market. The statement read, "With inflation quite low and resource use slack, the committee believes it can be patient in removing its policy accommodation. By using the word "slack," the Federal Reserve panel was alluding to the relatively high number of unemployed workers and the large amounts of unused factory capacity.

Given the Fed's statement that the risks of inflation and deflation were "almost equal," it comes as no surprise that the Fed is content with leaving interest rates unchanged, at least for the near future. Nevertheless, chairman Greenspan continues to warn that interest rates are too low to sustain indefinitely.

Since this is an election year, unless the Fed raises rates in the next couple of months, most analysts consider it unlikely that they will raise them until after the presidential election in November. Historically the Fed has refrained from taking any action that might seem to favor one party over another.



(Updated May, 2004)

Questions
1.

Define "federal funds rate" and differentiate it from the "discount rate." Which rate does the Fed control directly.

2. How can historically low interest rates stimulate job growth?
3. Discuss the "independence of the Federal Reserve" in view of the information in the last paragraph of the news story.
Source Edmund L. Andrews, "Citing Low Hiring, Fed Leaves Rates Alone," New York Times Online, March 17, 2004.

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