South-Western College Publishing - Economics  
Tight Money Policy Continues
Subject Interest Rates
Topic Monetary Policy
Key Words

Interest Rates, Inflation, Economic Growth

News Story

For the ninth consecutive time, the Federal Reserve has raised the federal funds rate, leaving little doubt that more increases will follow. The federal funds rate is the rate charged for overnight loans from banks with excess reserves to banks that need reserves to meet legal reserve requirements.

In a statement that accompanied the announcement, Federal Reserve officials repeated their previous declarations that monetary policy is "accommodative." This terminology means that interest rates are still lower than officials want. By raising interest rates, the Fed expects to slow spending and hold back inflationary pressures on the economy. Fed officials also stated that they expect to continue increasing rates at a "measured" pace without giving any indication of when they might slow or stop the trend toward higher interest rates.

"They didn't answer any questions today," said Peter Kretzmer, senior economist at Bank of America. "My feeling is that we will hear some things in July, but they certainly didn't want to indicate that now."

This ninth consecutive increase comes on the anniversary of the Fed's effort to reverse an easy-money policy it had followed since 2001 when it was fighting an economic slowdown. The Fed's goal now is to reach a "neutral" rate that will neither stimulate inflationary pressure nor put a brake on economic growth.

Investors were looking for a hint that the rate was getting closer to that "neutral" level, but the Fed policy makers made only minor changes to their description of the condition of the economy, and those minor changes simply reinforce the case for more rate increases.

"Although energy prices have risen further, the expansion remains firm and labor market conditions continue to improve gradually," members of the Federal Open Market Committee, the Fed's policymaking body, said in their statement. "Pressures on inflation have stayed elevated, but longer-term expectations remain well contained," the Central Bank said.

The latest measure from the Commerce Department on personal consumption expenditures, excluding energy and food, was up 1.6 percent in May over the same period a year ago. This measure is the Fed's favorite gauge of inflation and is well within the central bank's unofficial comfort zone of 1 to 2 percent.

Questions
1.

Distinguish between "tight-money" and "easy-money" policy.

2. Define the Federal Funds Rate.
3. Explain what the Fed means by "neutral" interest rates.
Source Edmund Andrews, "Fed Stays its Course a 9th Time," The New York Times Online. July 1, 2005.

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