Question

How successful was the Federal Reserve at lowering the inflation rate during the 1980s? Discuss.

Why is it important to have two measures of the Consumer Price Index, specifically, the Core CPI versus the CPI? Discuss.

Answer 1

The Fed raised the federal funds target rate from 11.2% in 1979 to 20% in June of 1981. The unemployment rate became higher than 10% during this time as well. The economy was restored by 1982 as a result of the tight-money policy put in place by the Fed. The Fed chose to enact a policy of preemptive restraint during the economic upturn which increased the real interest rates. The Fed's policy also pushed the President and Congress to adopt a plan to balance the budget. These actions of the Federal Reserve resulted in sound monetary and fiscal integrity that achieved the goal of price stability.

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living; the CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. Core CPI is a method for measuring core inflation. It is the consumer price index (CPI) excluding energy and food prices. There are many other methods for calculating core inflation, but this is the most popular measurement. This method has become the most widely used because food and energy prices can be very volatile, and this wide amount of movement would unfairly bias the measure of inflation.