Question

Federal Open Market Committee (FOMC): “Press Release” December 13, 2017 “Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate… [J]ob gains have been solid, and the unemployment rate declined further. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. On a 12-month basis, both overall inflation and inflation for items other than food and energy have declined this year and are running below 2 percent.

   Consistent with its statutory mandate the committee seeks to foster maximum employment and price stability… [T]he committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor markets conditions will remain strong. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term. Near-term risk to the economic outlook appear roughly balanced but the Committee is monitoring inflation development closely.

In view of realized and expected labor market conditions and inflation the Committee decided to raise the target range for the federal funds rate to 1-¼ to 1-½ percent. The stance of monetary policy remains accommodative.”

Explain in terms of an economist where the FOMC believes the Macroeconomics is as of 13 December 2017, what the FOMC’s policy is and why it is pursuing this policy given the current conditions as it describes them. How did the DOMC implement the fed funds rate adjustment described?

Answer 1

As per the given information, the economy has recovered from the recessionary impact of the financial crisis of 2008 and showing the signs of the growth. It can be established by the macroeconomic indicators. The labor market situations is improving. It means that new jobs are being created and it reduces the burden of unemployment benefits. With improvement in employment level, consumption spending increases and it is shown by the increase in aggregate demand. The firms are also responding with the increase in the investment spending. The short term inflation is below 2%, but there is a scope to rise it above 2% and the FOMC has the target interest rate of 2%.
Here, the Federal Reserve not only wants the economy to grow, but also to keep the price stability also in the economy. To do this, the federal fund rate is increased from 1.25% to 1.5%. It means that there is an effort to slowly remove the monetary policy stimulus and let economy to come on its own. Further, increase in Federal fund rate, will increase the interest rate. It will discourage the ugly consumption and investment spending. As a result, inflation will be under the control.
FOMC will reduce the money supply to implement the Federal fund rate. By selling government securities in the open market, funds will be sucked out of the economy. As a result, less money will be available for the disbursement and interest rate will increase. It will control the inflation.