Economics Money and Banking Federal Open Market Committee Project

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FOMC Project
Instructions
Spring 2020
Instructions: Suppose that Fed Chairman Jerome Powell and the eleven other members of the
FOMC have asked you to provide a 2,000-word paper (roughly 8-12 pages) outlining
what policy stance you think the Fed should take at its upcoming FOMC meeting on April 28th.
The key question that your paper should address is this: “what policy stance should the Fed
announce at its upcoming FOMC meeting?” Since the federal funds rate is the primary
instrumental of monetary policy, as we’ll discuss in class this semester, it makes sense to frame
your thesis in terms of it (e.g. “In light of current conditions, we advise the Fed to
[raise/lower/maintain] its target federal funds rate to X.XX%,” and back up your argument for
why the Fed should raise or lower its target rates with data and evidence. That said, as we’ll
discussed in class, today’s Fed also places a heavy emphasis on another key tool of monetary
policy: the interest rate paid on excess reserves. Be sure to include the discussion of this rate into
your analysis.
Although the primary question you are addressing is “What policy stance should the Fed
announce?”, it is helpful to think of your paper as needing to address two overarching questions:
(1) what should the Fed do? (2) why, using data and evidence, is this the right policy stance to
take? In other words, provide your thesis and support it with solid data and evidence. Your paper
can also explore topics including (but not restricted to): should the Fed reduce the size of its
balance sheet to reduce the risk of future inflation? Should the Fed adopt a rule, like NGDP
targeting or the Taylor Rule, for monetary policy moving forward? I want to give you some
leeway to delve into
Materials: To help you prepare for this assignment, I’ve posted some additional items to your
course Files under the subfolder: “FOMC Project”:
1. RUBRIC. Here is the grading rubrics I will be using for your papers:
GRADING RUBRIC (FOMC Paper).docx
2. SAMPLE PAPERS. In the attached file, I’ve provided a detailed example outlining (a) how
the paper should be structured and (b) what types of data and information I will expect you to
include in your recommendation. (I will permit you some leeway in titling sections and
subsections, but do not deviate from the structure outlined here.)
The information provided within this outline is from the FOMC report I wrote when I was in
college in 2011. You may use it as a guide for what I am looking for in terms of substance and
style, but *do not* try to emulate/plagiarize what I say: bear in mind, this is from 2011, so my
advice is outdated. Make sure that you have “All Markups” showing, as I will give you advice
and feedback in the comments bubble at each section.
FOMC Sample Paper (Spring 2011).docx
In addition, I’ve also included one of the best papers from an earlier semester. The information is
more up to date, so although you should NOT regurgitate their arguments (bear in mind
economic conditions have changed over the past six months), you should emulate their
organization and thoughtful analysis.
Your references (you should have at least, on average, one reference per page) should be written
in APA format, and included at the end of the paper (references DO NOT count towards your
total word count).
FOMC Sample Paper (Spring 2019).docx
3. Previous FOMC Minutes. Here is a link to the Fed’s press release and statements explaining
its most recent policy decisions. The arguments they use to support their decision should prove
helpful for your analysis. You can go back as far as you’d like, but it’s a good idea to start with
the most recent report and see what types of arguments they found most convincing for making
their ultimate policy decision.
https://www.federalreserve.gov/newsevents/pressreleases/monetary20190821a.htm
One of the best resources to use to find good data overviewing the state of the economy is the
Beige Book that is published by the Fed eight times a year. This is perhaps the best one-stop
source for important data on the current economic outlook:
https://www.federalreserve.gov/monetarypolicy/beige-book-default.htm
4. External Resources: Here are some other resources that might help.
Since the FOMC’s goal is to base their decisions in large part on what they expect looking
forward (not just looking backwards at recent data), one of the MOST IMPORTANT things you
should consider when putting together your proposal is what the most recent forecasts are for a
number of key variables like inflation, unemployment, nominal GDP growth, etc.
I like to use the Fed’s actual projections for inflation. The Cleveland Fed provides forecast that
can be found here: https://www.clevelandfed.org/our-research/indicators-and-data/inflationexpectations.aspx
Another good source for inflation forecasts comes from the University of Michigan’s survey of
inflation expectations, which surveys consumers to get a guage for how much they expect
inflation to rise over the next 12 months. You can find the latest details here:
https://fred.stlouisfed.org/series/MICH (NOTE: these are 12-month forward projections).
The best source for unemployment forecast would be the Congressional Budget Office. It issues
reports regularly that often have short term projections on a variety of key indicators ranging
from GDP and employment forecast to budget projections. You can find it here:
https://www.cbo.gov/about/products/budget-economic-data
Trading economics releases a fairly widely cited forecast of unemployment, so this would also
be acceptable.
https://tradingeconomics.com/forecast/unemployment-rate (Links to an external site.)Links to an
external site.
The OECD provides fairly good projections for things like real and nominal GDP. Scroll to USA
for ours.
https://data.oecd.org/gdp/nominal-gdp-forecast.htm
Of course, you are welcomed (and encouraged!) to use whatever other additional sources you
might think are relevant. If you have any questions about if a particular source is sound or
reputable, feel free to ask me.
Finally, here is the PDF of Excel shortcuts you might find handy when conducting your data
analysis. Please note that you do not have to re-produce any graphs or figures that you are able to
access via FRED, but if you’d like to analyze the data further and practice your chops with Excel
it might make for a productive exercise.
Microsoft Excel Shortcuts.pdf
FOMC Report/Presentation Overview
April 12, 2018
Overview of Economic Conditions
? Inflation forecasted at 2 percent on average over next 10 years (Cleveland Fed)
? Economy forecasted to grow relatively quickly in 2018 and 2019, after which the pace
slows during the following several years as the federal budget deficit rises substantially
(CBO)
? Federal debt to reach nearly 100 percent of GDP by 2028
? Public Law 115-97 (Tax Cuts and Jobs Act) significantly reducing revenues and
increasing outlays
? To increase GDP by 0.7% on average
? To increase non-farm jobs by 1.1 million
? Output to grow faster in 2018 than in 2017 (CBO)
? Recent changes in fiscal policy bolster current momentum in spending on goods
and services by providing incentives to work, save and invest
? Fiscal stimulus to bump GDP by 0.3 percent in 2018 and 0.6 percent in
2019
? Ensuing budget deficits reduce resources available for private investment,
counteracting bolstered GDP in the long run
? Growth in actual GDP to outpace potential maximum sustainable figures in 2018
and 2019, reducing the unemployment rate and placing upward pressure on
inflation and investment rates
? Real GDP to increase by 3.3 percent in 2018 and 2.4 percent in 2019,
compared with 2.6 percent in 2017
? Driven by consumer spending, business investment and federal spending
? Between 2020 and 2028, economic growth is projected to slow, eventually matching
CBO’s estimate of maximum sustainable rate of economic growth (CBO)
? 2020-2026: Economic growth to slow down due to higher interest rates and
prices, slower growth in federal outlays, and the expiration of reductions in
personal income tax rates
? 2026-2028: Economic growth projected to rise slightly, matching growth rate of potential
output by 2028 (CBO)
? 2018-2028: Actual and potential real GDP to increase by 1.9 percent on average
? 2020-2026 Real GDP: increase of 1.7% on average
? Potential output to grow more slowly than in recent decades
? Slower growth of labor force due to retirements of baby boomers
? GDP Forecast (OECD)
? GDP: 2016 $57,591.20/capita
? Nominal GDP: 2017 4.1 percent; 2018 4.7 percent; 2019 4.4 percent
? Real GDP: 2017 2.25 percent; 2018 2.54 percent; 2019 2.15 percent
? Unemployment Forecast (Trading Economics)
? Mar/18 4.1 percent; Q2/18 4.0 percent; Q3/18 4.0 percent; Q4/18 3.9 percent;
Q1/19 3.8 percent
Policy Recommendation
? Based on our examination of relevant economic data and forecasts, we have concluded
that maintaining the current federal funds rate of 1.75 percent in the immediate future is
most beneficial.
? Reasons for maintaining the current federal funds rate through 2018
? Economy is on track to maintain a steady 2 percent rate of inflation
(Cleveland Fed)
? Unemployment is set to steadily decline, allowing workers to earn more
money and increase their spending out of pocket. (Trading Economics)
? Federal funds rate can be increased by at least 25 basis points in 2019 if
economy heats up more than expected
? Provided future economic projections of a slowdown between 2020 and 2028, we have
concluded that a reduction in the federal funds rate may be necessary sometime after
2020
? Reasons to reduce federal funds rate during/after 2020
? 2020 may bring with it a downward turn in the economy due to higher
interest rates and prices (CBO)
? Significant reductions will be seen in the workforce due to a high number
of retiring baby boomers
? The 2026-2028 time frame does not necessarily bring with it bad
economic times, but only slower growth rates as compared with previous
years
References
CBO. (2018, April 9). The Budget and Economic Outlook: 2018-2028. Congressional Budget
Office. Retrieved from https://www.cbo.gov/publication/53651
Cleveland Fed. (2018, March 13). Inflation Expectations. Federal Reserve Bank of Cleveland.
Retrieved from https://www.clevelandfed.org/our-research/indicators-and-data/inflationexpectations.aspx
OECD GDP. (2016). Gross domestic product (GDP). Organisation for Economic Co-operation
and Development. Retrieved from https://data.oecd.org/gdp/gross-domestic-productgdp.htm#indicator-chart
OECD NGDP. (2018). Nominal GDP forecast. Organisation for Economic Co-operation and
Development. Retrieved from https://data.oecd.org/gdp/nominal-gdpforecast.htm#indicator-chart
OECD RGDP. (2018). Real GDP forecast. Organisation for Economic Co-operation and
Development. Retrieved from https://data.oecd.org/gdp/real-gdp-forecast.htm#indicatorchart
Trading Economics. (2018, March). Unemployment Rate – Forecast – 2018-2020. Trading
Economics https://tradingeconomics.com/forecast/unemployment-rate
FOMC Report
Title: “Trust the Process: the case for
sustaining a low federal funds rate in a
fragile recovery”
Prepared by: Scott Burns
Date: April 15th, 2011
Executive Summary
Based on the latest data, the economic recovery appears to be continuing at a slow but
steady pace. The latest reports issued by the U.S. Department of Commerce and the
Federal Reserve Board indicate an inflation rate of 2.2%, while real output growth
remained steady near 3%. Analysis from the April 13, 2011 Beige Book shows that
consumer spending has accelerated over the past few months. Despite the fact
unemployment remains well above its natural rate (currently measured at 8.8%) and
activity in many sectors remains fairly subdued, near-term outlooks are beginning to turn
more positive in each district as expectations of the recovery continue to strengthen.
Given the sedated pace of the recovery and some of the lingering fragility of the
financial sector, however, we recommend the Federal Reserve continue to maintain its
target range for the federal funds rate between 0 and 0.25%. As the recovery continues to
take hold, however, we believe policymakers should shift their focus from stabilizing the
financial system and stimulating aggregate demand to systematically draining reserves
from the financial system in a timely yet controlled fashion. Our proposed “exit strategy,”
outlined in more detail below, involves gradually reducing reserves through term deposit
facilities, reverse repurchase agreements and a controlled dose of open market sales—
raising the interest rate paid on reserves concomitantly with rises in the federal funds
target rate to systematically drain reserves out of the system without hampering the
incipient recovery and needlessly raising unemployment.
1
Overview of Economic Conditions
Nearly two and a half years after the onset of the “Great Recession,” many of the
leading economic indicators are beginning to show a glimmer of hope that the recovery
that began in late 2009 might finally be gaining a more solid footing. Reports from the
twelve Federal Reserve Districts included in the most recent edition of the “Beige Book”
indicated that economic activity generally continued to improve over the past couple of
months. [1] Though some districts described their improvements as merely “moderate,”
most districts reported gains across multiple sectors. In particular, the manufacturing
sector continued to report steady growth in output and hiring 10 of the 12 Districts. The
report also indicated consumer spending generally increased across most districts.
Perhaps most notably, reports focusing on the short-term economic outlook in each
district were more optimistic. Most districts reported improvements in labor market
conditions as hiring increased across various sectors. Though the national labor market
still suffers from persistently high unemployment, results so far this year have indicated a
slight strengthening in hiring and a marked decrease in unemployment claims since
December 2011. However, many analysts still fear that at least part of this improvement
is a result of workers “giving up” on their job search and leaving the civilian labor force:
Figure 1: Labor Market Statistics
2
On a slightly less sanguine note, many districts reported higher commodity cost were
putting increased pressures on input prices. Most notably, the rising price of energy and
raw materials generated ample concern among many firms and small businesses. These
rising costs could potentially squeeze profit margins and dampen hiring. Another major
concern cited by 7 of the Districts was the disruption and/or potential for disruption to
sales and production prompted by the tragic earthquake and ensuing nuclear crisis in
Japan. Moreover, the continuing conflict in the Middle East—specifically in oil rich
countries like Libya and, potentially, Saudi Arabia—has incited concern and speculation
about rising oil prices. The recent surge in oil prices has yet to exert a major impact on
U.S. markets, but that could change if oil prices rise further or maintain inordinately high
levels for extended period of time. The result of such an exogenous supply shock could
potentially raise inflation to levels higher than the Fed would’ve otherwise liked while
lowering real output below its natural rate. In the short run, however, these threats
shouldn’t drastically alter Fed policy, as they are largely out of the Fed’s control and, at
least for the time being, do not seem to warrant a major threat to general economic
recovery. Generally speaking, the most recent reports seem to indicate strong growth and
a satisfactory return to trend in inflation, real GDP, and nominal GDP, as shown below:
Figure 2: Nominal GDP, Real GDP and CPI Inflation
3
Policy Recommendation
Given all of the above information as well as the steady return of measures such as CPI
inflation, nominal output, and real output closer to their desired levels, the data seem to
indicate that the recent Fed policy of keeping nominal interest rates near zero and
providing ample liquidity to the financial markets has done an adequate job of stabilizing
the economy. Since the recovery is still fragile and unemployment remains above its
natural level, we recommend the Fed maintain its current targets for the discount rate, the
federal funds rate, and the interest rate paid on reserves for the time being, which can be
seen on the graph below.1 However, with the recovery standing on more solid footing, we
also believe it is time for the Fed to begin outlining its “exit strategy” in more specific
terms. Implementing a more “forward-looking” plan, especially as the recovery continues
to strengthen, will help the Fed reign in inflation expectations while providing market
participants with greater confidence that the Fed does indeed have a reliable strategy for
draining excess reserves and unwinding its current balance sheet holdings.
Figure 3: The Federal Funds Rate and Interest on Excess Reserves
1 Currently, the Fed Funds target rate is between 0-0.25%. The Discount Rate is at 0.75%, approximately a 50 BP spread over the
current Fed Fund target rate. The interest rate paid on both reserves and excess reserves remains at 0.25%. For now, we don’t advise
any shift in these targets. In the next section, however, we discuss why the Fed might consider adjusting these spreads in the future.
4
One of the major implications of the Fed’s bold and unprecedented interventions in late
2008 has been that it has injected an incredibly high level of reserves in the banking
system. Beginning in January 2009, the Fed started implementing QE1 to inject an
additional $1.7 trillion of non-borrowed reserves into the financial system. Of this $1.7
trillion in purchases, roughly $1.25 trillion were mortgage-backed securities, and the rest
were divided between agency debt and long-term securities. In late 2010, the Fed
announced QE2, which planned to purchase another $600 billion in long-term treasury
securities to fuel spending and directly impact long-term rates. The current Fed balance
sheet is at $2.5 trillion—roughly 2.5 times larger than it would’ve been had the crisis not
occurred. The structure of these assets differs drastically from what they would’ve been
under normal circumstances. The two largest assets on the Fed’s books are shown below:
Figure 4: Fed Assets
Shifting its focus from preventing mild deflation to preventing excessive inflation will
become the primary duty of the Fed over the coming months. But in order to do that, the
Fed first needs to devise a plan for draining reserves from the banking system before
higher interest rates lure all of those excess reserves out into the system and the “genie
gets out of the bottle,” laying the foundation for potentially high rates of inflation.
5
Assuming the recovery continues, our proposed “exit strategy” has 3 main aspects:
First, the Fed should implicitly cap its balance sheet to prevent any further expansion of
the monetary base. The Fed faces a daunting enough task as it is trying to contract its
balance sheet by draining reserves in a timely yet orderly fashion. Putting even more
pressure on its escape efforts would hardly do any good. Since QE2 is scheduled to cease
after 2011Q2, the Fed should consider discontinuing its purchases of long-term
treasuries, or at the very least weaning itself off QE2 gradually. If economic conditions
continue to improve, there should be no need to discuss the option of QE3.
Second, the Fed should make use of the newly implemented term deposit facility to shift
reserves out of the system and into interest-bearing time deposit accounts at the Fed. If
these efforts proved inadequate, another possibility would be for the Fed to sell its own
debt in the form of Federal Reserve Bonds to the public. This option, however, doesn’t
appear to be as likely and need not be pursued if other efforts are successful.
Finally, the Fed should begin the process of gradually trimming its balance sheet via
open market sales and reverse repurchase agreements. However, it’s worth noting that
reverse repurchase agreements would only have a transitory affect on reducing the
monetary base (unless they are continually rolled over), so this option is somewhat
limited. Moreover, the Fed will not likely pursue open market sales on too large a scale
because of the large amount of non-borrowed reserves it’d have to reduce in the process.
In addition to pursuing a low and steady dose of open market sales, the Fed should also
consider raising interest rates on reserves so it could effectively increase the federal
funds rate without having to drastically reduce the amount of non-borrowed reserves in
6
the system. This dual process of raising the interest rate paid on reserves and excess
reserves to lift the federal funds rate while slowly but steadily pursuing open market sales
and reverse repurchase agreements should provide an effective combination for draining
excess reserves out of the financial system in a timely yet orderly manner.
It should be noted that the above proposals only hold if the recovery continues at its
current pace. If, however, economic activity begins gaining some serious momentum,
velocity accelerates, and increased loan demand begins bidding up nominal interest rates,
the Fed might need to pursue more aggressive versions of these policies to keep inflation
and output from exceeding their sustainable target. If, on the other hand, economic
activity begins to stagnate or even decline, the Fed—rather than buying up more assets
and further bloating its balance sheet—might want to consider more creative responses
like eliminating or even charging negative interest rates on excess reserves to push funds
out into the open market rather than leaving them bottled up on the Fed’s books.
In any case, we are confident the Fed has ample weapons in its arsenal to combat
deflationary pressures. We are less confident, however, that the Fed has either the
practical capability or apolitical backbone to combat inflationary pressures should they
arise. These are unprecedented times, indeed, for the Fed and for our nation. As deficits
continues to rise and policymakers are forced to make tough decision regarding what to
do with the debt, it seems highly probable—especially with a large election cycle
approaching in 2012—that political pressures might hamstring the Fed’s efforts to do
what is necessary to keep the economy on a sustainable long-term path.
7
References
[1] “The Beige Book” April 13, 2011.
http://www.federalreserve.gov/fomc/beigebook/2011/20110413/fullreport20110413.pdf
[2] Federal Reserve Economic Data: The Federal Reserve of St. Louis.
http://research.stlouisfed.org/fred2/
[3] The Congressional Budget Office.
http://www.cbo.gov/
[4] Scott Sumner: “Sumner on Monetary Policy.” Econtalk with Russ Roberts. Library of
Economics and Liberty. November 9, 2009.
http://www.econtalk.org/archives/2009/11/sumner_on_monet.html
[5] George Selgin: “Between Fulsomeness and Pettifoggery: a reply to Scott Sumner.”
September 18, 2009.
http://www.cato-unbound.org/2009/09/18/george-a-selgin/between-fulsomeness-andpettifoggery-a-reply-to-sumner/
[6] George Selgin: “Selgin on the Fed.” Econtalk with Russ Roberts. Library of
Economics and Liberty. December 6, 2010.
http://www.econtalk.org/archives/2010/12/selgin_on_the_f.html
[7] Lawrence White: “The Threat to Sound Money and the Free Banking Solution.” April
4, 2011. George Mason University Economics Department.
http://gmueconsociety.blogspot.com/2011/04/larry-white-video.html
***Sources [4] through [7] are primarily cited in the addendum.
.
8
FOMC Report
Title: “Pumping the Brakes of the
Economy: Increase the Federal Funds
Rate”
Prepared by: Jane Doe and John Doe
Date: December 5th, 2017
Executive Summary
Today, the U.S. is experiencing a healthy economy that continues to grow. According to
the Federal Reserve Bank of St. Louis, the unemployment rate in the United States today is
currently 4.1% (lower than the natural rate of 4.5-5%), which proves a good state of the
economy. Also, nominal GDP has continued to strengthen. The current inflation rate is about
1.8%. Although this number is .2% below the target goal of the Fed, inflation is expected to
increase next year (FOMC, 2017). Janet Yellen, the Chairwoman of the Fed, asserted in her
speech this past October, “with the ongoing strengthening of labor markets, I expect inflation to
move higher next year” (Yellen, 2017). The Federal Open Market Committee (FOMC) should
increase the federal funds rate by conducting open market sales at their meeting next month. This
will cause interest rates to rise throughout the economy. Overall, there will be a decrease in the
money supply, and in turn, a decrease in inflation. Although inflation is currently below 2%, an
increase in the federal funds rate will not immediately push that rate lower. Due to a projected
increase in inflation, an increase in the federal funds rate should keep inflation lower, and
ideally, around the 2% target in the long run.
1
Overview of Economic Conditions
The U.S. economy is finally recovering from the devastating financial crisis that hit in
2008. After the recession, the Fed took multiple steps in order to start the recovery processes.
First, in December of 2008, the FOMC decreased the federal funds rate to essentially zero. This
rate was not increased until December of 2015, seven years later. Lowering the federal funds rate
by participating in open market purchases caused interest rates to decrease, which created
economic growth. The Fed also imposed an interest rate on excess reserves, which caused banks
to hold on to more of their money. If the banks were to allow borrowing, it would have increased
the overall price level. Another recovery step included quantitative easing: the purchase of
Treasury bonds, and mortgage-backed securities. The purchase of these assets stimulated
economic growth by increasing the total money supply, and decreasing the interest rates (U.S.
Economic Outlook, 2017).
Although some critiqued that this process of quantitative easing would increase inflation,
this did not happen because banks held on to excess reserves rather than lending them out to the
public. Therefore, the money was kept out of circulation. These asset purchases greatly expanded
the Fed’s balance sheet after the recession. After the third round of quantitative easing, the Fed’s
total asset balance reached $4.5 trillion. The below graph represents the growth in the Federal
Reserve’s total assets from 2007 to 2017. As shown below in Figure 1, the number of assets
increased exponentially following the crisis. The total assets continued to grow until about 2014
when the Fed stopped the quantitative easing process (Puzzanghera, 2017).
2
Figure 1: (All Federal Reserve Banks: Total Assets, 2017)
Currently, the federal funds rate is 1.25%. Although this rate was lowered to essentially
zero during the beginning of the recovery process, the Fed wants to continue to increase this rate
due to the current strength of the economy. The federal funds rate is the rate that banks charge
each other for overnight loans in order to meet the reserve requirements set by the Fed; this rate
is the FOMC’s greatest tool used to control the economy, and it affects many other economic
factors (Hamel, 2017).
Due to the current rate of inflation of 1.8%, overall consumer confidence level is high.
This means that they are willing to spend more money since the economy is stable and growing.
With this increase in spending, new businesses are able to enter the market and expand.
Expanding businesses will hire more workers because consumers are willing to spend more
money. This has caused unemployment to be very low at 4.1% (this number is lower than the
natural rate). Due to low interest rates, businesses have been able to expand because it is cheaper
to take out loans. All of these factors show significant economic growth (10-Year Breakeven
Inflation Rate, 2017).
3
Figure 2: Economic Predictions (Federal Open Market Committee, 2017).
The table above shows the FOMC’s projected economic indicators up to 2019. By using
the central tendency, there is a more accurate representation of the statistics. The unemployment
rate is predicted to be between the range of 4.3-4.7 in 2019, and the CORE PCE inflation, also
known as CPI inflation, is predicted to be between 2.0-2.1 by 2019 (Federal Open Market
Committee, 2017).
4
Figure 3: Nominal GDP 2008-2019 (Nominal GDP Forecast)
Another important economic indicator that shows the strength of the economy is the
nominal GDP. Figure 3 shows that the nominal GDP is currently about 4.1%. The projected
nominal GDP for next year is 4.7%: an increase of .6%. Nominal GDP measures the value of all
goods and services in the economy at current market prices (Nominal GDP, n.d.). This increase
reinforces the fact that the nation’s economic performance has been good, and it is projected to
maintain this stability in the future.
5
Policy Recommendation
Now that the economy has reached its target unemployment rate and inflation rate, the
Fed can begin the process of contractionary monetary policy. This policy will be implemented by
conducting open market sales, which entails selling their treasury notes and mortgage-backed
securities that they acquired during the quantitative easing process following the recession as
well as increasing the federal funds rate. We believe that the Federal Open Market Committee
should consider increasing the rate by .25% at their next meeting, so it will reach 1.5%. Selling
these assets will create an overall decrease in the money supply, which in turn, will increase the
rate (Amadeo, What is Being Done to Control Inflation?, 2017).
To control the continuing growth of the economy so that it does not overheat and
possibly lead to a repeat of the financial crisis of 2008, the Fed needs to pump the brakes on
economic growth with the use of contractionary monetary policy. There are concerns that as the
Fed continues to increase the federal funds rate, inflation will continue to decrease further than
the current rate of 1.8%, which could be a bad situation since the Fed’s inflation goal is 2%.
However, current economic indicators show that inflation is projected to increase in the future.
According to “Trading Economics”, core inflation is projected to increase to 2% in the next year.
By 2020, inflation is predicted to be around 2.2% (Trading Economics, 2017). Although
increasing the federal funds rate will decrease inflation, it takes time for the economy to adjust to
the change. By the time the economy feels the effect, the decrease in inflation will be
counteracted by the projected increase, which will maintain the target rate of inflation set by the
Fed.
Another possible concern with low inflation can be correlated to the fact that the
unemployment level and the inflation rate are inversely related, so low inflation could cause
6
higher unemployment. Although an increase in unemployment could potentially happen, the
current unemployment rate is 4.1% which is below the expected natural rate of 4.5-5% (Labor
Force Statistics from the Current Population Survey, 2017). So, an increase in unemployment
would not be detrimental to the economy since the rate is already so low. With an increase in the
unemployment level, there would be a greater number of structurally unemployed workers. This
type of unemployment, however, is beneficial for the economy in the long run as workers learn
new skills that can increase overall productivity and efficiency in the economy. An increase in
unemployment could be a potential side effect of increasing the federal funds rate, but this is a
possible benefit for the economy in the end.
Nominal GDP, another economic indicator, can help us decide whether or not to raise the
federal funds rate based on its change over the years. Because of the current strength of the
growth rate of Nominal GDP as seen in Figure 3, the FOMC can, and should, increase the federal
funds rate by .25% at the next meeting.
If the Fed takes no action regarding the federal funds rate, inflation could eventually
become unsustainable, so it is necessary to control