This afternoon, the Fed should have come out with a new dot plot. So let’s look at the old one for some background.
If you want to know how Federal Open Market Committee (FOMC) members feel about short-term interest rates, you can look at the dot plot. The dots display what members believe is the most appropriate rate for achieving their inflation and unemployment goals. The key word is “appropriate.” If a member is “hawkish,” she could project higher rates than a “dove” who expects less inflation.
In a recent talk, former Fed Chair Ben Bernanke warns us that the dot plot (formally known as SEP, the Summary of Economic Projections) is not a policy commitment nor is it an economic policy forecast. Since it expresses what members believe is “appropriate,” it reflects the “range of sentiment.”
This dot plot from the Fed’s last meeting shows the interest rate trend they think is appropriate. I’ve draw the pink arrows and note:
And these are the economic projections on which the dots are based:
Our Bottom Line: The Fed Funds Rate
The Fed targets a fed funds rate–a bank-to-bank lending rate– because they cannot actually set the rate. Instead, by injecting more or less money into the economy, they try to incentivize banks to lower or raise their lending rates.
To achieve a rate goal, the Fed digs into its policy toolbox. The first tool they usually grab is open market operations through which they buy and sell treasury securities. I tell my class to remember Boost the economy when they Buy securities. Then think Sink the economy when they Sell them. Also the Fed can raise or lower the discount rate and, much less typically, change banks’ reserve requirements. The newest addition to the toolbox was quantitative easing which we explain here.
The rate that will start to increase, the fed funds rate, has been close to zero for a long time:
My sources and more: Before today’s FOMC meeting on an interest rate hike, I took a look at their dot plots because their take on the economy could provide a good backdrop for today’s decision. The perfect complement, this Ben Bernanke talk explains the significance of their SEP (Summary of Economic Projections).