To make effective use of the tools it has,
the Fed needs to be able to predict the direction of the economy,
develop a policy response, put the policy into action, evaluate
the effects the policy is having, and make appropriate corrections
if the response is too weak or too strong.
Since the 1970s, the Fed has focused on steadily
reducing inflation and keeping it under control.
To keep inflation in check, including inflation
that it has anticipated might occur in light of a booming economy,
the Fed has controlled the
money supply
through open market operations,
nudging interest rates higher at what it determined were appropriate
times.
The Fed's strategy has been largely successful.
Of course, how quickly and how much rates should be raised is
a difficult decision to make. One reason is that until inflation
actually starts heating up, it’s hard to gauge when overall
demand for goods and services is outrunning the economy's productive
capacity. But if the Fed waits until that happens, it will be
behind the curve. So it believes the appropriate time for action
is when the risk of higher inflation is on the rise.
Anthony Santomero,
Federal Reserve
Bank of Philadelphia
Find out what forecasters use to predict the economy's direction.
A set of statistics known as the flow of funds shows where different sectors of the economy are getting their money and how they are using it. Forecasters try to predict how interest rates will behave by looking at this data, especially the fit between the availability of credit and the demand for it.
Anthony Santomero, 