Long Term Perspective

The Federal Reserve targets the federal funds rate (the rate that banks charge each other for the use of overnight funds) in order to loosen or tighten monetary policy. The nominal fed funds target rate, on its own, does not tell us whether monetary policy is tight or loose. It is easier to see whether policy is restrictive or accommodative by the relationship between the funds target rate and the inflation rate. We use the year-over-year change in the core (excluding food and energy) PCE (personal consumption expenditure) price index. When policy is accommodative, the gap between the two series narrows; when policy is tight, the gap widens. The core inflation rate, measured by the PCE price index excluding food and energy prices has firmed recently but remains below the Fed target rate of 2 percent. Changes in inflation tend to have long lags from changes in monetary policy.

 

 

Short Term Perspective

Fed officials have noted in speeches that headline inflation still is important since higher energy and food costs can seep into inflation expectations. In early 2011, higher energy and food costs bumped up headline inflation but then eased in latter 2011 and 2012. Core inflation turned up in 2011 and early 2012, partly due to a firming in shelter costs.  At the Fed's January 24-25, 2012 FOMC, it announced a specific long-term inflation goal of 2 percent.  Earlier the Fed had an implicit target range of 1-1/2 to 2 percent based on the long-term forecast range in its quarterly forecasts.  Both headline and core inflation eased in spring 2013 due to slower economic growth and lower energy costs.  This softness continued into early 2014 despite some monthly volatility in energy costs.  Core inflation began to nudge up inflation in mid-2014.