Long Term Perspective
The Federal Reserve targets the federal funds rate (the rate that banks charge each other for the use of overnight funds) in order to loosen or tighten monetary policy. The nominal fed funds rate target, on its own, doesn't tell us whether monetary policy is tight or loose. It is easier to see whether policy is restrictive or accommodative by the relationship between the funds rate target and the inflation rate. We use the year-over-year change in the core (excluding food and energy) PCE (personal consumption expenditure) deflator. When policy is accommodative, the gap between the two series narrows; when policy is tight, the gap widens. The core inflation rate, measured by the PCE deflator excluding food and energy prices has risen to the 2-1/4 percent vicinity - and is up from the 2 percent level generally held since 2004. Changes in inflation tend to have long lags from changes in monetary policy.

Short Term Perspective
While the Fed was boosting rates over the past tightening cycle, market players and analysts were trying to figure out where the Fed was headed when the Fed claimed that they were trying to reach a rate that would bring inflation down gradually - a rate somewhat above neutral. Now that there are signs that the economy is moderating, discussion have turned to when the Fed will ease. However, strong consumer spending in November has raised fears that it may be a while before that happens. Few expect a rate cut before mid-May 2007.