South-Western College Publishing - Economics  
Rates Steady Again
Topic Monetary Policy
Key Words Inflation and Interest Rates
News Story The Federal Funds Rate, the rate banks charge each other for overnight loans of excess reserves, remained unchanged in recent Federal Reserve action. The Federal Funds Rate is the rate the Fed refers to when it makes its interest rate announcements. The most recent decision to leave the rate unchanged marked a milestone of sorts. It has been one year since the Fed left rates unchanged, after many months of continuous increases.

Even with this decision, the Fed continued to say that inflation remains its “predominate policy concern.” They pointed out that a tight labor market a reduced availability of factory capacity could once again push inflation higher. Economists call this cost-push inflation and it occurs as businesses face increased costs of production and push those increased costs on to consumers in the form of higher prices.

The actual measure the Fed likes to use as a gauge of inflation is the “core” rate of inflation. Fed governors, including Chairman Ben S. Bernanke have set an unofficial goal of keeping the “core” rate of inflation, excluding volatile food and energy prices, at 1 to 2 percent per year. That measure is currently just above 2 percent and it has eased from about 2.4 percent in March.

Consumers are still facing higher prices in general. The overall rate of inflation, fueled by higher energy prices, actually rose in May by 2.7 percent. The Fed acknowledged the overall rise but also noted they are climbing more slowly in recent months. Instead of describing inflation as “elevated,” as it had before, the Fed’s statement said, “Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated.”

Fed policy makers are obviously in no hurry to raise interest rates and an increase should not be expected in the near future. Federal Reserve monetary policy will attempt to keep the federal funds rate steady by buying and selling securities in the open market.

Questions
Discussion Questions:
1. Visit http://www.clevelandfed.org/research/trends/2007/0607/01monpol_060607.cfm and scroll down until you discover a description of monetary policy aimed at keeping rates steady. Write a brief summary of the process.
2. In addition to open market operations, identify the other two tools the Fed can use to influence interest rates and the supply of money.
Multiple Choice/True False Questions:
1. The measure of core inflation excludes food and energy prices.
  1. True
  2. False
2. Open market operations refer to the rate the Fed charges member banks to borrow from the Fed.
  1. True
  2. False
Source Edmund L. Andrews, “Fed Keeps Interest Rates Steady”, The New York Times Online, June 29, 2007.
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