Since the 2008 recession, the Federal Reserve has maintained the target FFR at a historic low to help support the economy despite positive economic indicators like the decreasing unemployment rate and rising GDP growth. However, recent announcements by Janet Yellen, the current chair of the FED, have hinted an increase in the target FFR by December 16th and gradual interest rate hikes. Yellen hopes for further improvement in the labor market and that inflation eventually moves back to the 2% benchmark.1 The Fed must act carefully in 2016 to avoid any obstacles that may lead to another recession.
The Fed’s main instrument for monetary policy is open market operations, during which they buy and sell bonds from banks in an attempt to influence the FFR and thus other interest rates in the economy. The Fed acts under a “dual mandate”, which guides them to make effective monetary policies that move the economy towards maximum employment while still maintaining reasonable long-term interest rates.2 They face a tradeoff in fulfilling this mandate, since a naturally inverse relationship exists between increasing employment rates and keeping price levels stable. When setting rates the Fed must consider the unemployment rate, inflation rate, and
GDP growth rate. Since rates are currently near the zero lower bound (ZLB), the Fed wants to
increase them to the neutral rate in order to ensure that lowering rates is a viable monetary policy counterforce against economic contraction during