South-Western College Publishing - Economics  
Threat of Inflation Remains Uncertain
Topic Monetary Policy
Key Words Inflation and Monetary Policy
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Reference ID: A161887001

News Story In their March meeting of 2007 Federal Reserve officials agreed that interest rates may have to increase further to combat future inflation. At the same time they seemed to be concerned that the economy may slow on its own more than previously forecasted.

This dilemma was outlined in the minutes of the March meeting of the Federal Open Market Committee, the arm of the Fed that buys and sells securities in the open market to control the money supply and thus inflation.

While leaving short-term interest rates at the current 5.25 percent, the committee minutes stated, "In light of the increased uncertainty about the outlook for both growth and inflation, the committee also agreed that the statement should no longer cite only the possibility of further firming."

The minutes reflect the growing uncertainty of central bankers about which way the economy is actually going. On the one hand they recognize inflation is increasing but economic growth could be slowing. A move to increase interest rates could cause the growth to slow even more.

The Fed "is feeling an increased intensity and unpredictability of crosswinds in the outlook," Brian A. Bethune, an economist with Global Insight, said in a research note.

Earlier statements by the Fed have used the terminology of "additional firming"; meaning interest rates were likely to rise. The new statement from the March meeting allows the Fed a little more wiggle room and indicates the possibility that rates could move in either direction depending on the path of the economy.

"They're adding flexibility by acknowledging that there's at least some possibility of a rate cut," said Ethan Harris, chief United States economist of Lehman Brothers. "But that doesn't mean they're taking the eye off the ball here in terms of inflation."

The Fed is currently walking a tight rope with respect to interest rate movements. If they increase the rates to slow inflation they increase the chance of stalling potential economic growth.

Discussion Questions:
1. How does the Open Market Committee change the money supply?
2. Why is the Fed worried about increasing interest rates in the article?
Multiple Choice/True False Questions:
1. When the Fed wants to increase interest rates they sell securities in the open market.
  1. True
  2. False
2. The Federal Open Market Committee controls the money supply to influence inflation.
  1. True
  2. False
Source Jeremy Peters, "Rising Inflation May Mean More Fed Rate Increases", The New York Times Online, April 12, 2007.
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