South-Western College Publishing - Economics  
Interest Rates Nudge Upward
Subject Inflation
Topic Monetary Policy
Key Words

Inflation, Interest Rates, and Economic Growth

News Story

For the eighth consecutive meeting, the Federal Reserve has raised the federal funds rate, leaving little doubt that more increases will follow. While the Fed did recognize that sharp oil price increases had affected the economy, its goal of ensuring lower inflation took precedence. "Recent data suggest that the solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices," Fed officials said. They noted, however, that employment continues to increase and that employment trends reduce pressure to stimulate consumer spending by offering lower borrowing costs.

The Fed's goal, in fact, is just the opposite. Despite the apparent slowdown in economic growth over the last month or two, the Fed is sticking with earlier statements that the current interest rate level is still "accommodative" --and that the Fed's goal remains to keep nudging rates up until borrowing costs are no longer an economic stimulus as well as an inflation source.

RBS Greenwich Capital's chief economist Stephen Stanley said the recent Fed statement reinforced his sense that they were more worried about faster inflation than they were about slower growth. He expects the Fed to keep nudging short-term interest rates higher throughout the year. "Clearly, they are now worried about core consumer price inflation," he said. "There's no hint that they have any intention of stopping anytime soon."

"Inflation is now back at the top of the central bank's agenda," said Ian Shepherdson, who tracks the United States economy for High Frequency Economics, "and nothing short of a serious slowdown will remove it."

For many analysts, the Fed's decision to raise the federal funds rate was a foregone conclusion. The only question was whether the Fed would signal any change in its strategy of increasing rates in small increments until it reaches a "neutral level that neither hinders economic growth nor promotes inflation." Apparently, the Fed is staying on track with its "measured" increases in the short-term rates.

Questions
1.

What type of inflation is occurring when businesses pass on their higher costs to consumers?

2. Define the Federal Funds Rate and differentiate it from the Discount Rate. Which is usually higher? Why?
3. Do you consider raising interest rates by the Fed to be tight money or loose money policy? Explain.
Source Edmund Andrews and Jonathan Fuerbringer, "Fed Raises Rates but Bobbles Delivery," The New York Times Online. May 4, 2005.

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