by Calculated Risk on 5/10/2006 03:24:00 PM

UPDATE: Professor Thoma parses the FOMC statement: The FOMC Raises Target Rate to 5%

Using the Dallas Fed's trimmed-mean PCE inflation rate (6 month average, annualized) and the effective nominal Fed Funds rate, the Real Fed Funds Rate is now around 2.5% (assuming current inflation at the same level as March).


Click on graph for larger image.

This graphs shows the REAL Fed Funds rate for the last 20 years. The median is 2.9%; still higher than the current rate. Of course inflation could dip with all the rate hikes already in the pipeline and the REAL rate would increase even if the FED pauses.

But right now inflation, using the trimmed-mean PCE method, is still too high. The FED is probably comfortable with measured inflation in the 1% to 2% range.

The wildcard remains the housing market. If housing slows too quickly (see previous post with 20% drop in the MBA Purchase Index from last year) then the economy might slow quicker than expected and the FED will have overshot.

If inflation remains at this level, or continues to increase, then the FED will have to continue hiking rates.

The June meeting should be interesting.