On pg. 255 in your text, The Economics in Practice describes the increase in foo

Question

On pg. 255 in your text, The Economics in Practice describes the increase in food prices around the world in 2008. Since
food, in large measure, affects the real income of households, increasing prices will eventually push up wages and have an impact on the aggregate supply
curve. Central banks were very worried about the prospects for inflation becoming generalized. To stop inflation, what would the Fed be likely to do? What are
the consequences for the economy? Specifically, what would be the effects on employment and unemployment given the actions taken by the Fed? Respond
to at least two of your classmates’ postings.

Explanation / Answer

The federal funds rate is the rate at which banks lend out excess reserves to other banks. Bank reserves are a percentage of the funds on deposit at the bank. Reserve requirements are established and monitored by the Fed. Depository institutions must hold reserves in the form of vault cash or on deposit with the Federal Reserve banks. The Federal Reserve Board, through its open market operations, influences the amount of reserves in the banking system. By doing so, it influences the interest rate on these loans. (The influence part is why it's a targeted rate.) Higher interest rates on federal funds raise the bank's cost of money, necessitating higher interest rates on bank loans to customers. That's why you see the prime rate move in lock step with changes in the targeted fed funds rate. Higher short-term interest rates put a damper on commercial and consumer borrowing. That means less growth in the money supply. With less money in the economy, there's less upward pressure on prices. The classic definition of inflation is "too much money chasing too few goods." Increases in the fed funds rate work on the too-much-money part of the equation. It's somewhat counterintuitive, but an increase in the targeted fed funds rate, along with the corresponding increase in other short-term interest rates, can actually result in a decline in long-term interest rates. That's because the Federal Reserve Board is working to reduce inflationary pressures and, by doing so, reduce the size of the inflation premium required by investors in long-term notes and bonds.

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