ECON 318 Hefner April 26, 2005
Initially, the Federal Open Market Committee, FOMC, consists of the seven members of the Board of Governors and the presidents of the twelve Federal Reserve Banks. There are also alternates and President Jack Guynn, Atlanta, voted until Richard W. Fisher’s appointment as president of the Federal Reserve Bank of Dallas was effective on April 4, 2005. The members include: Alan Greenspan, Timothy F. Geithner, Ben S. Bernanke, Susan Schmidt Bies, Roger W. Ferguson, Jr., Richard W. Fisher, Edward M. Gramlich, Donald L. Kohn, Michael H. Moskow, Mark W. Olson, Anthony M. Santomero, and Gary H. Stern.[1] The committee is the most influential monetary policy-makers and meets eight times a year. The committee addresses the current and projected economic and financial conditions. The influential decisions are made with the intentions to increase, decrease, or keep short-term interest rates the unchanged which affects the state of the US economy. Furthermore, the committee uses some of the following economic indicators to develop the right policy for the current US economic state.
Initially, Real Gross Domestic Product is the major indicator of the condition of US economy. GDP is the total value of goods and services produced within the borders of the United States, despite of who owns the assets or the nationality of the labor used in producing that output.[2] However, Gross National Product or GNP calculates the productivity of the citizens of the US and the income from assets owned by US entities, no matter where it is located. The growth of productivity is measured in real terms, productivity without inflation. The GDP data is released quarterly and it is typically during the final week of the month immediately after the quarter’s end. The most important objective of the committee is to sustain monetary growth by means of full employment and price stability. Furthermore, the performance of the U.S. economy is evaluated by real GDP for the reason that it is the most wide-ranging measure. The evaluation of real GDP represents the existing outlook of monetary policy is consistent with the foremost goal and can be achieved in the course of observing the progression in the overall growth rate, the rate of unemployment, and the inflation rate.
Also, the Consumer Price Index is considered a useful statistic in evaluating the economy. CPI is an index designed to measure the change in price of a fixed market basket of goods and services. The market basket of goods and services is representative of the purchases of a typical urban consumer. However, if the basket of goods were kept up to date, this economic indicator could potentially be a better source when assessing the condition of the economy. The index is advocated to determine real price change only. Another drawback to this indicator is that attempts are made to remove changes in price because of changes in quality, as quality increases the price increases and as quality decreases the price decreases. The frequency of the CPI data is released monthly and is generally available the second week of the month immediately following the month for which data is being released. The CPI is always released after the Producer Price Index, PPI. The committee uses the rate of change of the CPI as one of the key measures of inflation for the U.S. economy. Since, the increase or decrease of inflation may imply that a modification in monetary policy is needed. In the graph below, it shows that real GDP and the consumer price index illustrate a positive correlation, real GDP is increasing as the CPI is increasing, during the quarters of the years 2000 through 2005.
[1]
Nonfarm Payroll Employment is an approximation of the quantity of payroll jobs at all nonfarm business establishments and government agencies. The frequency of the Nonfarm Payroll Employment data is released monthly typically on the first Friday of the month for the previous month. The committee utilizes the employment growth and the number of hours worked to present important information regarding the overall economic growth presently and in the future. The average number of hours worked per week and average hourly and weekly earnings provide information which is beneficial in connection with the position of the US economy. The changes in average hourly earnings provide information about supply and demand outlook in the US labor markets. Furthermore, it may provide signals about the overall level of resource utilization in the economy. In the graph below, it shows that real GDP and total nonfarm employment exhibit no connection during the quarters of the years 2000 through 2005.
[2]
Other economic indicators, Industrial Production as well as Capacity Utilization are indexes designed to measure changes in the level of output in the industrial sector of the economy. The indicators are arranged by products, including consumer goods, business equipment, intermediate goods, and materials, and industry consisting of manufacturing, mining, and utilities. The frequency of the data is released monthly and the rough estimation is released around the middle of the month for the previous month. While the industrial sector of the economy represents only about 20 percent of GDP, because changes in GDP are heavily concentrated in the industrial sector changes in this index provide useful information on the current growth of GDP. The level of capacity utilization in the industrial sector provides information on the overall level of resource utilization in the economy which may in turn provide information on the likely future course of inflation. In the graphs below, it shows that real GDP and Industrial Production exhibit no relationship during the quarters of the years 2000 through 2005; however, Capital Utilization demonstrates a positive correlation with real GDP since March of 2003.
[3]
[4]
In 2005, the committee decided in February to raise its target for the federal funds rate 2.25 percent to 2.5 percent.[5] Inflation and longer-term inflation expectations remain well contained. The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters to be roughly equal. With underlying inflation expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.
Presently in 2005, the committee has raised the target for the federal funds rate 25 basis points to 2.75 percent during the March meeting and reiterated that a “measured” pace of increase would be implemented to keep inflation in check.[6] In addition, the discount rate was raised 25 basis points to 3.75 percent. [7] Since the contraction began, the fed funds rate and discount rates have been raised 175 basis points. Due to the increases at a “measured pace,” the status of monetary policy continues to be adjustable with beneficial essential growth in productivity and exhibits constant assistance considered necessary for the economy. The labor market is improving gradually justifying the stable growth of output regardless of the increase in energy prices. Additionally, the pressures on inflation have accelerated lately causing pricing power to become more evident. One source of those pressures is the US economy's rapid rate of growth so far this year. In spite of this, consumer prices have yet to be affected by the rise of energy prices. Moreover, the committee will take action to alterations in economic situation when needed to achieve the obligation of maintaining price stability.
Ultimately, the committee needs to be clearer about an inflation target to help successfully maintain price stability. The saying “measured pace” has provides useful guidance, so far, in the limited time it has been used. However, not all modifications can be considered as developing at a “measured pace.” From preceding statistics and showing potential of the “measured pace” approach, the rates should be constantly increase by 25 basis points because increasing the federal funds target rate is needed to anticipate inflationary pressures. There is a possibility that at some point in the future that there should be an acceleration of rates. Simultaneously, the possibility should not come immediately. However, financial markets are right to expect an increase in the rate by a quarter of a percentage point at each of its upcoming meetings scheduled in May, June, August and September, to 3.75 percent by fall. Furthermore, the US should foresee the rate at 4 percent by year-end.
[1] http://www.bls.gov/cpi/home.htm and www.bea.doc.gov/bea/dn/gdplev.xls
[2] www.bea.doc.gov/bea/dn/gdplev.xls and http://www.bls.gov/ces/home.htm
[3] www.bea.doc.gov/bea/dn/gdplev.xls and http://www.econstats.com/IPCU/ic__m1.csv
[4] www.bea.doc.gov/bea/dn/gdplev.xls
[5] http://www.federalreserve.gov/
boarddocs/press/monetary/2005/20050202/
[6] http://www.federalreserve.gov/
boarddocs/press/monetary/2005/20050322/
[7] http://www.federalreserve.gov/
boarddocs/press/monetary/2005/20050322/
