South-Western College Publishing - Economics  
Tough Tone On Inflation
Topic Taxes, Spending, and Deficits
Key Words Taxes, Tax Revenues, and Cost of Production
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Reference ID: A146663972

News Story When it comes to taking a stand on fighting inflation vs. promoting employment and economic growth, the Federal Reserve under Ben Bernanke will likely err on the side of fighting to keep inflation low. Congress handed the Fed a dual mandate of price stability and full-employment in 1977. A recent Labor Department report revealed that the nation added an estimated 75,000 nonfarm jobs in May--only half as many as needed to absorb the normal increase in the labor force.

These lower jobs numbers indicate slower economic growth, and some analysts speculated that the lack of economic growth would encourage the Fed to stop its recent policy of incrementally increasing interest rates-perhaps even encourage monetary policymakers to drop rates. Given Fed chairman's Bernanke's latest remarks, though, a rate decrease is not likely.

"Core inflation, measured over thee past three to six months, has reached a level that, if sustained, would be at or above the upper range that many economists, including myself, would consider consistent with price stability," Mr. Bernanke said. The core inflation rate leaves out food and energy in computing price increases. Food and energy prices fluctuate markedly and quickly; thus these components are not deemed as important in determining whether inflation is becoming embedded in the economy. Prices rose at a 3 percent annual rate over the last six months and 2.3 percent over the last 12 months; well above the 1 to 2 percent per year range that the Fed views as an acceptable level of core inflation.

"He's trying to send a pretty fair message that he's going to err on the side of doing more rather than doing less," said Jan Hatzius, chief United States economist at Goldman Sachs. Mr. Hatzius has been predicting that the Fed would not raise rates in June.

Instead of highlighting signs of a cooling economy, which would ease inflationary pressures, Mr. Bernanke placed top emphasis on keeping an eye on inflation. "Given recent developments, the medium-term outlook for inflation will receive particular scrutiny," Mr. Bernanke said. "There is a strong consensus among the members of the Federal Open Market Committee that maintaining low and stable inflation is essential" for achieving the central bank's dual goals of price stability and full employment. The Federal Reserve, he continued, "will be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained."

Discussion Questions:
1. Discuss the conflict between the Fed's dual mandate of price stability and full employment.
2. Why does the Fed prefer to use the core inflation index rather than a broader-based index that would include food and energy prices?
Multiple Choice/True False Questions:
1. The core inflation rate does not include food and energy prices.
  1. T
  2. F
2. If the Fed's sole goal of monetary policy was to increase employment, the information in the article would recommend lowering interest rates.
  1. T
  2. F
Source Edmund Andrews, "Bernanke Talks Tough on Inflation", The New York Times Online, June 6, 2006.
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