Long Term Perspective
The real (inflation-adjusted) rate of interest indicates the degree of constraint in the financial market. In this case, the federal funds rate (controlled by the Fed) is compared to the yearly change in the core personal consumption expenditure deflator, that is, the PCE deflator excluding food and energy prices. A wide gap is evident in the late 1990s, and this points to relatively restrictive monetary policy, not an unusual occurrence during an economic expansion. When the core PCE deflator and the fed funds rate were equal in 2002 and 2003, it signaled an accommodative policy stance. The gap widened in 2004 as the Fed tried to achieve a more neutral policy. The fed funds rate finally became higher than the inflation rate in 2005 after several the Fed raised rates several times in 2004 and 2005. The gap remained high in 2006 as the Fed continued to boost the fed funds target during the first half and held steady in the latter half. The core PCE deflator had yet to respond much in 2006 to the Fed's tightening.

Short Term Perspective
The Fed ended its streak of 17 consecutive interest rate increases when the Fed chose to not raise the fed funds target at it August 8, 2006 FOMC policy meeting. The rate remains at 5.25 percent. Fed officials are still concerned about potential inflation with comments by Fed officials focusing on stubbornly high core inflation and tight labor markets. Fed statements have indicated that future policy moves are dependent upon incoming data and on changes in their own forecasts. The Fed's favorite inflation indicator, the core PCE deflator, remains above the Fed's comfort zone (1 to 2 percent).