The Times is publishing regular briefings on economic issues to coincide with Target Two Point Zero, the Bank of England competition for sixth-formers run with the newspaper. The contest challenges students to play the role of the Bank’s Monetary Policy Committee (MPC) and recommend the best level for interest rates.

This week: ahead of its latest decision on interest rates on Wednesday, the role of the US Federal Reserve.

What are the differences between the Fed and the Bank of England?

The key difference between the two central banks is their remits from government. While Britain’s MPC has one chief goal, to meet the 2 per cent inflation target set each year by the Chancellor, the Fed’s far broader brief, set in law by the US Congress, is to maintain stable prices while seeking to foster growth and maximise US employment. This is the Fed’s “dual mandate”. The Fed also puts more emphasis than the Bank of England on “core inflation”, measured after stripping out volatile food and energy costs.

Have these differences changed recently?

Yes. The Fed has edged towards declaring a specific target for inflation like the MPC’s, but not explicitly. Instead, the Fed announced in November that it will release forecasts for its favoured measure of inflation three years ahead. Since this is the period over which the Fed can be reasonably sure of determining inflation levels, its forecast effectively amounts to a target.

Are there differences in the way in which decisions are announced?

Unlike the MPC, the Fed decisions are always accompanied by a statement. The wording of this is a key way in which the Fed shapes financial market views of the economy, and of its likely next moves.

What rates does the Fed set?

The Fed’s main instrument is the Fed Funds target rate. Changes to this rate for loans of overnight money to US institutions feed through to market interest rates in a similar way to that in which UK Bank rate affects Britain. The Fed also sets a largely symbolic Discount Rate, for emergency borrowing by US banks. In recent times this assumed greater significance because of strains in the world’s credit markets as banks’ hoarding of capital made it hard for them to borrow from each other.

How important are Fed decisions for Britain?

Crucial. The huge size of the US economy means that Fed decisions are a driving force in the global economy and exchange-rate developments.

What is happening to Fed policy?

From 2000 to 2003, the Fed cut rates to an historic low of 1 per cent to shore up America’s economy as it fought fall-out from stock markets’ “dot-com” bust. From June 2004 to June 2006, it raised the Fed Funds target rate back to a high of 5.25 per cent, before holding it at that until last September.

Since then, and until last week, with the US economy threatened by sliding house prices, money market turmoil and a credit squeeze, the Fed has cut US rates three times by a total of a percentage point to 4.25 per cent. Last Tuesday, it responded to fear of a US recession and more market upheaval with an emergency three-quarter-point cut in rates before this week’s meeting.

What is influencing the Fed?

Pressure for the Fed to act this month was magnified by sell-offs in global equity markets. Another influence was a leap in US unemployment last month to 5 per cent, from 4.7 per cent, amid signs of the jobs market weakening markedly. A further factor was an Institute of Supply Management survey showing that activity in US manufacturing shrank in December. At the same time, housing market developments have remained relentlessly bleak. The Fed will still worry over persistent inflation – at a headline annual rate of 4.3 per cent in November, and at 2.3 per cent on the “core” measure - above its preferred 2 per cent ceiling. However, it is more concerned by threats to growth and jobs.

Read previous briefings

For more on the contest

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