Plain Sense Economics

The Federal (Reserve) Open Market Committee (FOMC) announced last week that it was lowering its main interest rate target, the Fed Funds Rate, by one quarter of a percent. You can read the statement they released here.

Part of their statement and deliberations include concern about inflationary pressures. So they have to balance the need to stimulate a sluggish economy with the need to prevent an inflation price spiral.

When the FOMC changes a target interest rate, there are some near term, almost immediate changes in a few, related interest rates. One example is the prime rate, which banks charge their best, usually corporate, customers for short term, unsecured loans. The prime rate follows the direction of the Fed Funds Rate target pretty closely.

The economic impact of these changes doesn’t hit right away, however. In fact it can take six to nine months for the impact to work its way through the economy. That means the FOMC is looking at current economic conditions, but it also is trying to predict what conditions will be like in six to nine months. They wouldn’t want a stimulus accommodation (lower interest rates) to hit just as the economy is picking up speed and adding pressure to inflation.

So, like duck hunters, the FOMC must aim not for where the duck is now; they must aim for where the duck will be.