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 necessarily 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, remains below the Fed target rate of 2 percent. Changes in inflation tend to have long lags vs changes in monetary policy.

 

 

Short Term Perspective

In January 2012, the FOMC 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. Both headline and core inflation eased in spring 2013 due to slower economic growth and lower energy costs with softness continuing into 2014. Then the price of oil collapsed, moving in six months roughly in half from $100 to $50 and then over the next several months to below $40 and pulling down PCE readings.