Fed Funds Target Rate and Inflation

Chart of the Week for November 12-18, 2004

Since July, the Federal Reserve has raised the fed funds rate by a total of 1%, a result of four one–quarter point increases. The rate is currently at 2.00%, following this week’s hike. The fed funds rate is a key instrument of monetary policy. Decreasing the fed funds target rate is viewed as expansionary and an attempt to stimulate the economy, while increasing the fed funds target rate is viewed as contractionary and an attempt to slow the economy. During periods of economic growth, the Federal Reserve considers raising this key rate in an effort to control potential inflation.

One measure of inflation is the Consumer Price Index (CPI), which measures the average change in prices paid by urban consumers for a fixed basket of goods and services. As can be seen form the chart, the fed funds rate has tracked inflation closely in the past, but more recently, the rate has been kept low relative to inflation. The fed funds rate is currently 0.50% below inflation as measured by the CPI. As the economy continues to grow and inflation accelerates in response, the Federal Reserve may continue raising the fed funds rate.

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