Stable prices in a long-term run are requirements for moderate long-term interest rates, maximum employment, and sustainable output growth. This is because, when prices are stable, the prices of services, goods, labor, and other materials are usually less affected by inflation. They also provide guidelines for the allocation of national resources and support services, thereby contributing to higher standards of living (Grey, 2002). Additionally, stable prices normally enhance capital formation and savings. This is because when the value of assets are being eroded due to inflation, there is always a need guard the assets against losses. This usually encourages businesses to invest more while households are encouraged to save more (Grey, 2002).
The Federal Reserve Banks control the market for balances, which provides the initial link between the economy and the monetary policy. Depository institutions usually hold accounts at the Federal Reserve Banks, and they trade their balances at the federal funds market at a certain interest rate referred to as the federal funds rate (Grey, 2002). The Federal Reserve Banks have significant influence on the federal funds rate via its influence over demand and supply of the balances, at its premises. The Federal Reserve Banks normally set the federal funds rate at a level, which enhances monetary and financial conditions that are consistent with the monetary policy objectives. These banks also manipulate their targets that are consistent with the emerging economic developments (Grey, 2002). Therefore, a slight change in the federal funds rate and expectations about the future targets of federal funds rate can trigger a number of events, which will affect other long-term interest rates, short-term interest rates, stock prices, and foreign exchange of the dollar (Grey, 2002). Changes in these variables, in turn, affect businesses and households’