updated 6/26/2006 3:43:58 PM ET 2006-06-26T19:43:58

Federal Reserve Chairman Ben Bernanke has made clear he'll go to the mat to knock down inflation, increasing the likelihood that interest rates will rise again at the end of the Fed's two-day meeting on Thursday.

Major Market Indices

Other Fed chiefs also have sought early in their tenures to show their inflation-fighting resolve. Here are some questions and answers about why they believe inflation is such a threat.

Q: Why is the Federal Reserve concerned?
A: Once inflation gets a grip on the economy, it can be hard to break. A rapid rise in prices erodes the purchasing power of consumers. It can squeeze companies' profits, too, and that can make employers reluctant to hire workers and boost capital spending. It can diminish returns on investments. If consumers and companies clamp down on spending in response to rising prices and interest rates, the economy can be thrown into a recession.

Q: What exactly is inflation?
A: A rise in the prices of goods and services. In economist-speak, inflation occurs when too much money is chasing too few goods.

Q: How does the Fed treat inflation?
A: The Federal Reserve boosts interest rates. Those higher rates make it more expensive for consumers and businesses to borrow. That can curb their appetite to spend, which in turn can moderate economic growth and that can lessen inflation pressures.

The goal for Bernanke and his colleagues is to push up rates enough to quell inflation but not too much as to tip the economy into recession. It's a tricky task.

Bernanke's predecessor, Alan Greenspan, engineered such a "safe landing" for the economy after the Fed's 1994 to early 1995 rate-raising campaign, which some say helped usher in a record-long economic expansion. But the Greenspan Fed, following two other rate-boosting cycles, also saw the economy tip into recession — once in 1990 and again in 2001.

Q: When was the United States' last major bout of inflation?
A: Inflation flared past 12 percent in 1974, calmed down and then boiled over at the end of the 1970s and into the early 1980s. Paul Volcker took over the Federal Reserve in 1979 and that year inflation — as measured by the consumer price index — jumped 13.3 percent.

That was up from a big 9 percent increase in 1978 and marked the largest increase since 1946, when wage and price controls lifted after World War II sent prices soaring by 18.1 percent, economists say.

In 1980, consumer prices jumped by a smaller, 12.5 percent. Eventually prices settled down after Volcker ratcheted up interest rates to levels not seen since the Civil War to get inflation under control.

But Volcker's successful inflation battle did have a price: two recessions in the early 1980s and the nation's monthly unemployment rate soared past 10 percent.

Q: What are current barometers saying about inflation?
A: Although inflation is picking up, the situation is not even close to approaching the double-digit inflation dangers of the `70s and early `80s. Consumer prices for the first five months of this year raced ahead at an annual rate of 5.2 percent — outpacing the 3.4 percent rise for all of 2005.

Core prices, which exclude food and energy, are advancing at a 3.1 percent pace so far this year. That compares with a 2.2 percent increase in 2005. Fed policymakers pay close attention to measures of core inflation.

Q: Why are core inflation measures important to Fed policymakers?
A: When measuring core inflation, energy and food prices, which can swing widely, are removed so economists can get a clearer picture of how other prices are acting.

One core inflation measure closely watched by the Fed, dubbed the core PCE, for personal consumption expenditure, rose 2.1 percent in April from the same month a year ago. That was the biggest such increase in 13 months and was above the Fed's comfort zone of 1 percent to 2 percent core inflation.

Q: If inflation takes off, what does it mean for me and my pocketbook?
A: You'll be paying more for goods and services. If those prices are going up faster than your wages, your paycheck in effect will shrink, straining your budget and your lifestyle. Inflation also can eat into investment returns. Climbing interest rates often seen in an environment of rising inflation make it more expensive for people to pay their debts, buy a home or finance a loan to pay for a vacation or a child's education.

Q: Bernanke has talked about tracking consumers,' investors' and businesses' expectations about where inflation will head in the future. Why is that important?
A: If people and companies think inflation will get worse a year from now, they can change their behavior in ways that make it a self-fulfilling prophecy.

For instance, if workers think inflation will be higher a year from now, they are more likely to push for pay raises now. If businesses think their costs will be greater in the future, they may be more inclined to boost their prices. If investors believe inflation will rise in the future, they'll demand more compensation, which contributes to higher interest rates.

If consumers, investors and companies have faith in the Fed's ability to stop inflation from taking off, they are less likely to act in these ways.

Copyright 2006 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

Discuss:

Discussion comments

,

Most active discussions

  1. votes comments
  2. votes comments
  3. votes comments
  4. votes comments

Data: Latest rates in the US

Home equity rates View rates in your area
Home equity type Today +/- Chart
$30K HELOC FICO 4.91%
$30K home equity loan FICO 5.20%
$75K home equity loan FICO 4.57%
Credit card rates View more rates
Card type Today +/- Last Week
Low Interest Cards 13.42%
13.40%
Cash Back Cards 17.92%
17.92%
Rewards Cards 17.13%
17.12%
Source: Bankrate.com