The Fed has consistently said that it will not raise the federal funds rate any

Question

The Fed has consistently said that it will not raise the federal funds rate any time soon. The Fed’s challenge will be how to get monetary policy back to normal over the next several years. The Fed has to make a judgment about timing—tightening too early could send the economy back into recession, as happened during the late 1930s; waiting too long would set the stage for inflation.                                  Source: The New York Times, November 5, 2009

If the recovery continues and inflation starts to rise, what effect will the Fed’s decision to not change the federal funds rate have on the U.S. economy?

Explanation / Answer

Federal Funds Rate means interest rate at which bank institution lends funds maintained at the Federal Reserve to another bank institution overnight. The federal funds rate is usually applicable to most creditworthy institutions when they borrow and lend overnight funds to each other. The federal funds rate is one of the most influential interest rates in the U.S. economy, since it affecting monetary and financial conditions which includes employment, growth and inflation. Thus change in interest rates can have positive and negative effects on the U.S. markets. When the Fed changes rate at which banks borrow money, it has been observed that it will ripple effect across the entire economy. So Fed defines monetary policy as its actions to influence the availability and cost of money and credit. Because the expectations of market participants play an important role in determining prices and economic growth, monetary policy can also be defined to include the directives, policies, statements, and actions of the Fed that influence future perceptions.

Thus if the recovery continues and inflation starts to rise, some of the effect of the Fed’s decision not to be change the federal funds rate have on the U.S. economy will be as –

Therefore Fed’s decision to not change the federal funds rate or interest rates can affect the economy by influencing stock and bond interest rates, consumer and business spending, inflation, and recessions and by adjusting the federal funds rate, the Fed helps keep the economy in balance over the long term.

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