Friday, May 6, 2011

Fed Watch

The Federal Open Market Committee concluded its meeting Wednesday with no change in its policy instrument, the federal funds rate. This interest rate is the rate at which banks borrow from each other. The Fed can influence the rate by making bank reserve more plentiful or less. When the Fed buys US Government securities from banks, the Fed is increasing the supply of bank reserves or by selling US Government securities to banks, they decrease the supply of reserves. More reserves tend to push the fed funds rate down and fewer reserves tend to push it up.

Recently the Fed has been under pressure to tighten up its policy and conduct policy to increase interest rates. This policy would tend to fight inflation and increase the value of the US dollar. Individuals proposing this tend to be most concerned about possible inflation and the rising price of oil, partly caused by the falling price of the US dollar.

The European Central bank recently acted to increase interest rates. This is not a surprise since they have a very narrow purpose to keep inflation low, regardless of the growth rate of the economy.

The majority of the members of the FOMC have been on the side of keeping interest rates low. They are more concerned about the slow growth of real GDP and higher than desired unemployment than any possible inflation. Their assessment of inflation is that it will stabilize below 2% over the next several months. 

With low stable inflation, the FOMC is focusing policy on stimulating the economy. Low interest rates and a cheap dollar are believed to increase spending in the United States.

For now, the FOMC speaking for the Fed has decided to continue its policy of low interest rates.

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