This paper examines how the Federal Open Market Committee determines monetary policy in the United States and analyzes key macroeconomic indicators as of mid-2014. The paper explains the three primary mechanisms through which the Federal Reserve influences money supply—open market operations, discount rate setting, and reserve requirements—and evaluates their effects on inflation and employment. The analysis includes detailed assessment of U.S. GDP growth, employment trends, consumer price index changes, and manufacturing orders, alongside comparative economic conditions in Europe and Japan. Based on Taylor principle analysis, the paper evaluates the FOMC's decision to maintain the federal funds rate at 0–0.25 percent in the context of economic data.
Monetary policy consists of the actions taken by a central bank to change the supply of money and interest rates, thereby affecting economic activity. In the United States, the Federal Reserve establishes monetary policy. It works to ensure that the money supply grows neither too quickly—which would cause excessive inflation—nor too slowly, which would hamper economic growth. The Federal Reserve aims for an ideal inflation rate of 2 percent to 3 percent annually to keep prices stable. Additionally, the Fed seeks to maintain unemployment at approximately 5 percent.
The Federal Reserve influences money supply through three primary mechanisms:
Buying and selling U.S. treasuries through open market operations: When the Federal Open Market Committee buys treasuries from security dealers in the market, it increases the money supply and lowers interest rates. Conversely, selling treasuries to security dealers removes money from circulation, decreasing the money supply and raising interest rates.
Setting the discount rate: The Federal Reserve establishes the interest rate that banks with excellent credit ratings pay on overnight loans from the Federal Reserve Bank, known as the discount rate. Banks with lower credit ratings must borrow at higher rates. The Federal Reserve Board of Governors oversees this function.
Establishing reserve requirements: The Federal Reserve requires banks to hold a certain percentage of deposits on hand—for example, 10 percent—to meet customer withdrawals. Banks lend out or invest the remaining 90 percent to earn income. Banks deposit any excess funds with their district Federal Reserve Bank, making those funds available for other banks to borrow at a discount rate to maintain their reserve requirements.
The level of bank reserves affects the short-term interest rates that banks charge each other for overnight borrowing and lending, which helps banks maintain required reserve levels. These reserve levels subsequently affect the interest rates that banks charge consumers for products like car loans and mortgages, and they influence the overall inflation rate in the economy.
Gross domestic product is the broadest measure of goods and services produced across an economy. In the third quarter, U.S. GDP expanded at a 3.5 percent rate. In the second quarter, real GDP increased to 4.6 percent. This expansion signals sustained growth fueled by American consumers and businesses, despite mounting concerns about the health of overseas economies. Growth in real GDP reached 3 percent for the quarter, driven by positive contributions from personal consumption expenditure, exports, nonresidential fixed investment, and government spending at all levels.
Increased imports negatively impacted GDP. The economic report showed broad-based gains across the economy despite a decline in inventories. The decrease in growth compared to the second quarter resulted from declines in many measures other than federal government spending, which increased to 4.6 percent due to defense spending.
The Price Index for gross domestic purchases increased to 1.3 percent, down from 2 percent in the second quarter. Real personal consumption expenditures increased to 1.8 percent, compared to 2 percent in the previous quarter.
Corporate profits increased to $164.1 billion in the second quarter, compared to a decrease of $201.7 billion in the first quarter. Corporate income taxes rose to $45.7 billion in the second quarter, compared to an increase of $66.9 billion in the first quarter.
The unemployment rate dipped to 5.9 percent in September, with 248,000 jobs created in the U.S. economy. As the jobless rate declines and payrolls remain relatively steady, prices may rise due to tightening labor market conditions.
Among the unemployed, the number of job losers and persons who completed temporary jobs decreased by 306,000 in September to 4.5 million. Long-term unemployed individuals accounted for 31.9 percent of the total unemployed. The civilian labor force participation rate changed slightly to 62.7 percent, while involuntary part-time workers increased to 7.1 million. The overall labor force increased by 2.2 million. Notably, the number of discouraged workers increased from 154,000 to 698,000. Total nonfarm payroll employment rose by 248,000 in September.
Employment gains in September were distributed across multiple sectors:
Professional and business services added 81,000 jobs, with employment services accounting for 34,000 of those gains. Management and technical consulting services added 12,000 positions, and architectural and engineering services added 6,000. Retail trade employment increased by 35,000, with food and beverage stores contributing 20,000 jobs. Health care added 23,000 positions, information technology added 12,000, and mining added 9,000 jobs. Leisure and hospitality added 20,000 positions, construction added 16,000, and financial activities added 12,000.
Employment in other major industries—manufacturing, transportation, wholesale trade, and government—increased only modestly. By contrast, legal services employment declined by 5,000.
The Consumer Price Index (CPI) measures inflation. The U.S. Bureau of Labor Statistics calculates two types of CPI statistics: CPI for urban wage earners and clerical workers (CPI-W) and a broader index (CPI-U). The CPI-U is considered the better measure because 85 percent of the population is urban.
According to the seasonally adjusted CPI-U, prices increased by 0.1 percent in September.
Food: The food index increased 0.3 percent in September compared to the previous month's 0.2 percent increase. Indices for meats, poultry, fish, eggs, beef, veal, dairy, and related products rose in September, while indices for nonalcoholic beverages, fresh vegetables, cereals, and bakery products declined.
Energy: The energy index decreased by 0.7 percent in September, marking a third consecutive decline. Indices for gasoline, electricity, and fuel oil fell during this period, while the natural gas index increased.
All items less food and energy: The index for all items excluding food and energy increased by 0.1 percent in September, compared to neutral movement in August. Indices for rent, medical care, alcoholic beverages, and personal care increased, while indices for new vehicles, apparel, recreation, and household furnishings remained unchanged.
Non-seasonally adjusted CPI-U increased by 1.7 percent over the preceding 12 months, raising the index level to 238.031. The CPI-W increased by 1.6 percent, raising its index level to 234.170.
New orders: New orders for manufactured durable goods fell by $3.2 billion, or 1.3 percent, in September. New orders excluding transportation declined 0.2 percent, and defense orders fell 1.5 percent. Transportation equipment orders decreased by $2.8 billion, or 3.7 percent.
Shipments: Shipments of manufactured durable goods increased by $0.1 billion, or 0.1 percent, in September. Fabricated metal products shipments rose by $0.2 billion, or 0.6 percent.
Unfilled orders: Unfilled orders for manufactured durable goods increased by $3.8 billion, or 0.3 percent, in September. Transportation equipment unfilled orders rose by $1.0 billion, or 0.1 percent.
Inventories: Inventories of manufactured durable goods increased by $1.8 billion, or 0.4 percent, in September. Transportation equipment inventories rose by $1.0 billion, or 0.8 percent.
Capital goods: Nondefense new orders for capital goods declined by $4.6 billion, or 5.4 percent, in September. Defense new orders for capital goods increased by $0.6 billion, or 7.4 percent.
Europe: The euro area's economic recovery, which began in spring 2013, stalled in the second quarter of 2014, with GDP declining 0.3 percent. Industrial production dropped to 0.2 percent from the previous quarter's 0.8 percent. Private consumption expenditure increased from 0.4 percent to 0.6 percent, while government consumption expenditure decreased from 0.6 to 0.2 percent. Net exports of goods and services improved from −0.5 to 0.2 percent. Investments and inventories fell from 0.7 to −0.7 percent.
The European unemployment rate remained stable at 11.5 percent in August 2014, with 18.326 million people out of work and actively seeking employment. Employment growth has been steady since mid-2013, increasing by 0.2 percent in the first quarter and 0.3 percent in the second quarter.
The euro area Consumer Price Index increased to 118.19 index points in September 2014, compared to 117.68 index points in August 2014.
Japan: Japan's GDP fell by 7.1 percent in the second quarter of 2014, worse than preliminary estimates. The unemployment rate stood at 3.5 percent in the second quarter of 2014, just below its previous crisis level of 3.8 percent in the fourth quarter of 2007, making it one of the lowest rates among OECD countries.
"Policy evaluation using Taylor principle framework"
Always verify citation format against your institution’s current style guide requirements.