Fed Sees Both Unemployment, Prices on Rise

The Federal Reserve sees worse economic problems ahead . But even so, the Fed may be reluctant to cut interest rates any further than it already has . The Fed lowered its economic growth forecast for the year. At the same time, it reaised its projections for inflation and unemployment . The Fed raised its unemployment forecast  to between 5.5 percent and 5.7 percent  [and] now expects personal consumption expenditures to rise between 3.1 percent and 3.4 percent in 2008 . . [and] expects steeper "core" inflation . In an effort to keep the country from falling into recession and to deal with the credit crisis, the Fed has cut its key federal funds rate seven times since September. This short-term interest rate is now 2 percent, down from 5.25 percent at the start of the Fed's easing campaign . Some believe the Fed cuts since last September helped fuel inflation, especially the sharp run-up in oil prices, because the rate cuts have led to a weakening of the dollar. Along those lines, the two Fed members who voted against the last rate cut  argued during the meeting that the Fed cuts were hurting the economy more than heping it. CNN, May 21, 2008

a. Explain the inteded effect of the Fed cutting the target federal funds rate from 5.25 percent to 2 percent and illustrate your explanation with an appropriate graphical analysis.

b. Explain how this monetary policy may have "helped fuel inflation, especially the sharp run-up in oil prices."

c. What is core inflation and why does the Fed tend to focus on that measurement of inflation more heavily than overall inflation?

d. Explain the dilemma that the Fed is facing when making decisions in the face of rising unemployment and rising inflation.