South-Westerns' Economic News Summaries
Fed May Stop Hiking Interest Rates
Topic Monetary Policy
Key Words Monetary Policy, Interest Rates, and InflationHurricanes, Interest Rates, and Energy Prices

News Story

As Alan Greenspan prepares to retire as Fed Chairman, the Federal Open Market Committee has set the stage for ending eighteen months of continually increasing interest rates as a hedge against inflation. The targeted federal funds rate--the rate banks charge each other for overnight loans of excess reserves--has increased steadily by a quarter-point since the Fed first felt it necessary to hold off inflation.

Now Fed officials agree that they would probably have to push rates only a little higher before stopping their stated policy of gradual increases. This information comes from the recent minutes of the Federal Open Market Committee—the policy-making arm of the Fed.

“Given the information now in hand, the number of additional firming steps required probably would not be large,” the minutes said, ascribing that view to “most members” of the rate-setting Federal Open Market Committee. The meeting minutes confirmed that Fed officials have become slightly less worried about inflation, but that they do expect high energy prices to push overall prices—and thus inflation—higher for a while. “Participants indicated that their concern about near-term inflation pressures had eased somewhat,” the minutes said. The consensus was that prices were being held in check by competition from foreign producers.

“Views differed on how much further tightening would be required,” according to the minutes. “Members though the policy outlook was becoming considerably less certain and that policy decisions going forward would depend to an increased extent on the implications of incoming economic data.”

The last couple of years have been characterized by a rather predictable Fed. From 2001 to 2004, the Fed reduced interest rates far below normal, hoping to invigorate a stalling economy. By 2004, policy makers largely agreed that inflation was a possibility and that rates needed to be brought back to a more normal level. This is when the predictability began. Chairman Greenspan told lawmakers in 2004 that returning rates to normal without disrupting the economy overall would be his biggest policy challenge. “It’s not a gimme putt,” he said, using a golf metaphor. This is where rates began to increase at a “measured pace.”

Greenspan’s successor, Mr. Bernanke, has agued that the Fed needs to be more “transparent”, but he has not said that he favors advance guidance as a matter of principle. Future policy coming from the Open Market Committee may not be as predictable as in the recent past. As the minutes said, “…policy decisions going forward would depend to an increased extent on the implications of incoming economic data.”


Discuss how the federal funds rate relates to monetary policy. How does the federal funds rate relate to the discount rate?

2. Discuss how increasing interest rates affect inflation.
Source Edmund Andrews, “Fed’s Notes Offer Hope of a Brake on Rates”, The New York Times Online, January 4, 2006.
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