The opening text reads as follows: The Federal Reserve (the Fed) the United States central bank. Central banks determine a country’s monetary policy (the process of setting interest rates in an effort to influence economic conditions).

The illustration below shows a Federal Reserve bank balancing price stability and maximum sustainable employment on either side as in a weighing scale. The text reads, The Federal Reserve has been given a dual mandate: price stability, maximum sustainable employment

Inflation target: A publicly stated goal for the inflation rate. The Fed has an inflation target of 2 percent.

Why don’t the Fed target 0 percent inflation?

Inflation greases the wheels of the labor market

The Fed can lower real interest rates by more

The risk of inflation

Measured inflation may be overstated.

Federal funds rate. The interest rate that the Fed uses as its policy tool, which is the nominal interest rate banks pay to borrow from each other overnight in the federal funds market.

Starts with neutral interest rate leads to Targets the nominal interest rate in order to influence the real interest rate leads to compares inflation to its inflation target leads to looks at the gap.

A Fed rule-of-thumb approximates what it does. The equation below reads as follows:

Federal funds rate minus inflation equals neutral interest rate plus one over 2 times (inflation minus 2 percent) plus output gap.

Side note pointing to Federal rate minus inflation reads The real interest rate is what the Fed really cares about so it adjusts for inflation.

Side note pointing to Federal funds rate reads This is nominal interest rate the Fed controls.

Side note pointing to neutral interest rate reads, The real interest rate that would keep the economy neutral.

Side note pointing to the value 1 over 2 reads, raise the rates by one half of ellipsis

Side note pointing to Inflation minus 2 percentage reads, ellipsis the gap between inflation and the Fed’s 2 percent target.

Side note pointing to Output gap reads, Raise rates by the gap between actual and potential output.

The text continues as follows:

Tools the Fed uses to influence the federal funds rate

1. Pays interest to banks on excess reserves

2. Borrows money overnight from financial institutions

3. Lends directly through the discount (sets a ceiling) window

4. Buys and sells government bonds (what is used to do)

1 and 2 sets a floor on the federal funds rate.

Monetary policy choices when nominal interest rates are zero:

Forward guidance: Provide information about the future course of monetary policy in order to influence market expectations of future interest rates.

Quantitative easing: Purchasing large amounts of longer-term government bonds and other securities in an effort to put downward pressure on longer-term interest rates.