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Figure 12-4: Inflation drives interest rates
Figure 12-04
Over the years, the Federal Reserve Board has used the Discount Rate (more recently the Fed Funds Rate) to influence economic growth, raising rates to fight inflation in strong economies, and lowering them to stimulate demand in times of economic weakness. Sharp movements in prices of key aspects of consumer spending, particularly energy, can have an effect on inflation that is beyond the Fed’s control. Nevertheless, it is clear from this chart that these two key economic indicators are closely tied.
Current Comment: The Fed Funds Rate has been barely above “zero” % since yearend 2008, while consumer price inflation has now risen to over 3%. Any longer-term movement in interest rates from this point can only be to the upside, an obvious risk that investors in stocks and bonds must monitor carefully.
Sources: PCE deflator: Bureau of Economic Analysis Discount rate: Federal Reserve H15 Federal funds effective rate: Federal Reserve H15
*Discount rate until year end 2000, fed funds rate thereafter
Updated: 10/3/15