South-Western College Publishing - Economics  
Are Low Interest Rates About to End?
Subject Interest Rates
Topic Monetary Policy
Key Words Interest Rates, Monetary Policy, and Federal Funds Rate
News Story

As the economy grows and more firms hire new employees, the Federal Reserve may be inclined to depart from its commitment to cheap money. Recent moves by the Fed have left the federal funds rate at 1 percent, the lowest level in 45 years. The main reason for the low rates has been the Fed's concern that deflation may put a damper on an already weak economy.

The worry about deflation continues among Fed officials. Alan Greenspan, in a speech given to the Securities Industry Association, said that the Fed was still more worried that inflation would be too low rather than too high. He further suggested that the Fed would be patient when it comes to changing monetary policy. The chairman did add the caution that "no central bank can ever afford to be less than vigilant about the prospects for inflation."

Greenspan's speech left little doubt that the Fed wants to keep interest rates low for the near future. However, it also offered a guarded hint that the long-standing commitment by the Federal Reserve to easy money may be fading.

One analyst suggests that the Fed may have an "exit problem" related to their commitment to low interest rates. William Dudley, chief United States economist at Goldman Sachs says, "I think they want the exit to be gradual and smooth rather than abrupt and scary." If Dudley is right, the record low interest rates of recent times may be a thing of the past.

(Updated January, 2004)

Questions
1.

Define federal funds rate. How does it affect other interest rates in the economy?

2. Discuss the Feds lingering fear that inflation may be too low. How can inflation, which almost everyone agrees is a bad thing, ever be "too low"?
3. The opposite of easy money is tight money. Describe a monetary policy that results in tight money.
Source Edmund L. Andrews, "Greenspan Hints at End to Low Rates," The New York Times Online, November 7, 2003.

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