Magazine article Economic Trends

Monetary Policy

Magazine article Economic Trends

Monetary Policy

Article excerpt

After the surprise of a smaller-than-expected cut in the federal funds rate at the June 24-25 meeting of the Federal Open Market Committee (FOMC), market participants see little chance of a further rate cut. Attention apparently has focused on the language of the FOMC's press release: "The Committee continues to believe that an accommodative stance of monetary policy, coupled with still robust underlying growth in productivity, is providing important ongoing support to economic activity. Recent signs point to a firming in spending, markedly improved financial conditions, and labor and product markets that are stabilizing."

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Since early spring, the Chicago Board of Trade has provided a market for options on federal funds futures. Prices on these options enable one to estimate the implied probabilities associated with alternative policy choices. Just before the FOMC's June meeting, the implied probability distribution showed that the odds favored a rate cut of 50 basis points, with a slight chance that no change would be made. This revealed concern that the FOMC would need to act aggressively to avoid a potentially corrosive deflation. The choice of a smaller rate cut seemed to reassure markets that an unwelcome fall in inflation was unlikely. …

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