Long Term Perspective
The real (inflation-adjusted) rate of interest indicates the degree of constraint in the financial market. In this case, the federal funds rate (controlled by the Fed) is compared to the yearly change in the PCE (personal consumption expenditure) deflator. When the PCE deflator and the fed funds rate were equal in 1992, it signaled an accommodative policy stance. As the gap widened in the 1990s, it meant that monetary policy grew more restrictive. This is not unusual during an economic expansion, however.

Short Term Perspective
The Fed reduced the funds rate target 25 basis points on December 11 bringing the cumulative drop to 475 basis points for this year. As long as the fed funds rate is higher than the inflation rate (measured by the yearly change in the PCE deflator) the Fed still has room to move to become more accommodative. The latest reading (October) for the PCE deflator shows a 1.5 percent yearly change - which brings the real fed funds rate to 0.25 percent. Economists are predicting one more 25 basis point rate cut in January 2002.