Fed Monetary Policy

Fed Monetary Policy

Subject : Economy

Section: External sector

The US central bank will continue aggressive monetary tightening for as long as it takes to bring inflation towards the long-term goal of 2 per cent since the core PCE index — used by the Fed to measure inflation — continues to be at a three-decade high of 4.6 per cent.

Fed Reserve and the Monetary Policy:

• Monetary policy in the United States comprises the Federal Reserve’s actions and communications to promote maximum employment, stable prices, and moderate long-term interest rates--the economic goals the Congress has instructed the Federal Reserve to pursue.
• The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy.
• The Federal Open Market Committee FOMC’s primary means of adjusting the stance of monetary policy is by changing its target for the federal funds rate.
  • The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.
• The FOMC has the ability to influence the federal funds rate--and thus the cost of short-term interbank credit–by changing the rate of interest the Fed pays on reserve balances that banks hold at the Fed.
  • A bank is unlikely to lend to another bank (or to any of its customers) at an interest rate lower than the rate that the bank can earn on reserve balances held at the Fed.

How changes in the federal funds rate affect the broader economy?

• Federal funds rate changes are rapidly reflected in the interest rates that banks and other lenders charge on short-term loans to one another, households, nonfinancial businesses, and government entities.
•  The rates of return on commercial paper and U.S. Treasury bills--which are short-term debt securities issued by private companies and the federal government, respectively, to raise funds–typically move closely with the federal funds rate.
• The rates charged on longer-term loans are related to expectations of how monetary policy and the broader economy will evolve over the duration of the loans, not just to the current level of the federal funds rate.
• Variations in interest rates in the United States also have a bearing on the attractiveness of U.S. bonds and related U.S. assets compared with similar investments in other countries
• Changes in the relative attractiveness of U.S. assets will move exchange rates and affect the dollar value of corresponding foreign-currency-denominated assets (appreciation of dollar)
• Have implications for a wide range of spending decisions made by households and businesses. 
  • The FOMC eases monetary policy resulting in lower interest rates on consumer loans elicit greater spending on goods and services along with investments, Thus, raises employment.

The PCE price index (PCEPI)

• It is also referred to as the PCE deflator, PCE price deflator, or the Implicit Price Deflator for Personal Consumption Expenditures (IPD for PCE) by the Bureau of Economic Analysis (BEA) and as the Chain-type Price Index for Personal Consumption Expenditures (CTPIPCE) by the Federal Open Market Committee (FOMC),
• It is a United States-wide indicator of the average increase in prices for all domestic personal consumption. 
• It is benchmarked to a base of 2012 = 100.
• The less volatile measure of the PCE price index is the core PCE (CPCE) price index, which excludes the more volatile and seasonal food and energy prices.
• In comparison to the headline United States Consumer Price Index (CPI), which uses one set of expenditure weights for several years, this index uses a Fisher Price Index, which uses expenditure data from the current period and the preceding period.
• This price index method assumes that the consumer has made allowances for changes in relative prices. That is to say, they have substituted from goods whose prices are rising to goods whose prices are stable or falling