June 26, 2000

Fears of an overheated economy have led the Fed to raise interest rates in the hopes of slowing the economy and averting a rise in inflationary pressures. The theoretical basis for this policy recommendation can be found in the Phillips Curve, which, in its simplest form, posits a positive relationship between real GDP growth and the inflation rate. According to this view, if carefully calibrated, the increase in interest rates will slow the economy to its "normal" or sustainable rate while simultaneously wiping out any inflationary pressures. In other words, if properly implemented, the rate hike will produce a "Soft Landing." Thus, according to the Phillips curve the success of the Fed is determined by whether they can engineer this (presumably, desirable) soft landing.

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