South-Western EconNews

Steady There, Mr. Bernanke

Topic

Monetary Policy

Key Words

Interest Rates, Inflation, and Economic Growth

News Story

The Fed often walks a tight-line between controlling inflation and encouraging economic growth and employment. When the Fed raises interest rates to fight inflation, they run the risk of lowering economic growth or increasing unemployment. The policy-making arm of the Fed has believed for 17 consecutive meetings that it needed to raise interest rates to fight inflation and cool the economy. Each time, the Federal Open Market Committee (FOMC) hoped that the rate hikes would not cool the economy to the extent that the hikes would hinder economic growth and increase unemployment. At their most recent meeting, the FOMC decided to hold interest rates constant. This shift in policy is intended to allow what chairman Bernanke calls a “soft landing”—allowing the U.S. economy to cool inflation without causing a jump in unemployment.

The move was not without critics, who suggest that strong inflationary pressures still exist—in fact, core inflation has climbed recently--but the Fed expects such pressures to moderate over time. “There hasn’t been even a whisper of inflation pressures easing,” said Lehman Brothers’ chief economist Ethan Harris. “It’s amazing that the Fed can sound that comfortable on a day that you’ve had another piece of bad news on the inflation front. If I were on the Fed, I would have voted for another rate increase.”

In a statement that accompanied its decision, the Fed acknowledged that inflation had accelerated. But it predicted that slowing economic growth--led by cooling conditions in the housing market--would lead to moderating inflationary pressures soon. “Readings of core inflation have been elevated in recent months,” the Fed’s policy-making committee said. “However, inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.”

The central bank left itself ample room to resume its rate increases if inflation proves more stubborn than expected. But it implied that it hoped to avoid any more increases for the foreseeable future. In a sign of uncertainty among policy makers, the Fed committee was not unanimous in it decision to hold rates steady. This is a relatively rare occurrence in a committee that strives for consensus. Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, has often sounded the alarm about inflation and this time he argued for another rate hike. This was the first such dissent since Mr. Bernanke took over the reigns from Alan Greenspan in February. The age old trade-off between inflation and unemployment has haunted economic policy makers for years, and is likely to continue in the future.

Questions

Discussion Questions:
1.	Use any source available to identify the make up of the F.O.M.C. Do you think that the F.O.M.C. reflects a broad enough range of opinion to represent the U.S. economy?
2.	Discuss and expand on Bernanke’s notion of a “soft landing.”
Multiple Choice/True False Questions:
1.	The F.O.M.C. referred to in the article is the committee that adopts monetary policy in the Fed. True False
2.	The phrase used in the article, “cumulative effect” suggests that there is a lag between when a monetary policy is implemented and when it takes effect. True False

Source

Edmund Andrews, “In Policy Shift, Fed Calls a Halt to Raising Rates”, The New York Times Online, August 9, 2006.

Instructor Discussion Notes

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