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In December 2006, it was reported that the Federal Reserve would keep the interest rates unchanged for a long while, perhaps through most of 2007.  This is because the economy is showing mixed results at present.  Inflation is high, and so the Federal Reserve could have reduced interest rates to defeat the problem.  However, decreased economic activity in the housing market has slowed down the rate of economic growth (Idaszak & Goldstein, 2006).  A slowing of the rate of economic growth, no doubt, calls for raising interest rates.  Yet the Federal Reserve cannot raise interest rates while the economy faces high inflation.The decisions made by the Federal Reserve to change or keep steady the rates of interest do in fact influence economic activity.  What is more, economic activity has a direct influence on interest rates, seeing that it is economic activity in the nation that leads the decisions on interest rates.  Investors foresee changes in economic activity and rates by analysis.  The predictions they make lead to important investment decisions impacting the entire economy.  Thus, a normal yield curve is the result of an expectation of stable economic growth and rates (See Appendix).  On the other hand, a steep yield curve is made whenever investors have foreseen extraordinary growth.  At times when long-term yields are the same as short-term rates, investors see a flat or humped curve.  This is when an “economic slowdown and low interest rates follow a period of flattening yields” (“The Living Yield Curve”).  The Federal Reserve is, of course, absolutely connected to the expectations of the investors as well as all kinds of yield curves.At present, the Federal Open Market Committee, which formulates the monetary policy, has chosen to maintain the federal funds rate at 5-1/4 percent.  According to Chairman Ben S. Bernanke (2007), this monetary policy would most probably foster stable economic growth, and eventually slow down inflation.  However, if this monetary policy fails to slow down core inflation, the Federal Open Market Committee would have to specifically address the risk of inflation through a change in policy.The Federal Reserve cannot simply increase the funds rate to reduce the core inflation rate at this time, seeing that the economy continues to show mixed results.  Chairman Bernanke refers to this growth as “uneven.”  Although real economic activity in the country expanded at a good pace in the year 2006, the housing market continued to cool substantially.  Now if the Federal Reserve were to increase interest rates, the housing market would be expected to slow down in terms of economic activity even further.  This is the principal reason why the Federal Reserve would not increase interest rates to reduce the core inflation rate.Apparently, only the housing market is making the economic growth uneven today.  The core inflation rate is another problem facing the economy, perhaps caused by the remainder of the economy still growing rapidly.  Because the economic growth is uneven, however, the Federal Reserve Board believes that the United States is presently going through a transition after rapid overall growth experienced in recent years.  At present, the economy is cooling down to a more “sustainable growth rate.”  Consumer spending is strong.  According to Chairman Bernanke, “Consumer spending continues to be the mainstay of the current economic expansion.”  If the Federal Reserve were to increase interest rates at present, consumer spending would decrease.  All the same, as pointed out before, the Federal Open Market Committee may very well decide to raise the federal funds rate if, in fact, the current monetary policy fails to gradually reduce the core inflation rate.  Also according to Chairman Bernanke, “economic forecasting isan uncertain enterprise.”  Hence, policymakers at the Federal Reserve must be prepared to deal with changes in the economy as they arrive.  Flexibility is of the essence.  The Federal Reserve is ready to deal with inflation with changes in the federal funds rate if and when it is ‘foreseen’ as a necessity.  The investors, on the other hand, now have a chance to enjoy the normal yield curve as the basis of their investment decisions.

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