December 13, 2012 10:20:37 AM
WASHINGTON -- The Federal Reserve sent its clearest signal to date Wednesday that it will keep interest rates super-low to support the U.S. economy even after the job market has improved significantly.
The Fed said it plans to keep its key short-term rate near zero until the unemployment rate reaches 6.5 percent or less as long as expected inflation remains tame. Unemployment is now 7.7 percent.
That plan adds detail to what the Fed had said before: that it expects to keep the rate low until at least mid-2015. For the first time, the Fed is making clear to investors and consumers that it will link its actions to specific economic markers.
"This approach is superior" to setting a timetable for a possible rate increase, Chairman Ben Bernanke said at a news conference. "It is more transparent and will allow the markets to respond quickly and promptly to changes" in the Fed's economic outlook.
Bernanke made clear that even after unemployment falls below 6.5 percent, the Fed might decide that it needs to keep stimulating the economy. Other economic factors will also shape its policy decisions, he said.
"The Fed has become more explicit and more transparent," said Steven Wood, chief economist at Insight Economics. "This should provide the markets with much more clarity around monetary policy action in the upcoming year."
In a statement after its final policy meeting of the year, the Fed said it will also keep spending $85 billion a month on bond purchases to drive down long-term borrowing costs and stimulate economic growth.
The Fed will spend $45 billion a month on long-term Treasury purchases to replace a previous bond-purchase program of an equal size. And it will keep buying $40 billion a month in mortgage bonds.
Those purchases, and the Fed's commitment to low rates, are intended to spur borrowing and spending in an economy still growing only modestly 3 years after the Great Recession ended.
Still, Bernanke warned that none of the Fed's actions could outweigh the economic pain that would be caused by sharp tax increases and government spending cuts that are set to kick in next month. The standoff between President Barack Obama and Republican lawmakers over how to resolve the "fiscal cliff" is already hurting the economy and threatens to push it into a recession next year, he said.
Fed policymakers are hopeful that the crisis can be resolved without significant long-term economic damage, Bernanke said. They foresee slightly faster growth next year and a gradual decline in unemployment.
Bernanke's comments about the impact of the fiscal cliff seemed to raise some concern among investors. Stocks had risen after the Fed's statement was released. But by the end of Bernanke's news conference, market averages were mixed. The Dow Jones industrial average closed down about 3 points. The Standard & Poor's 500 index rose fractionally.
With its new purchases of long-term Treasurys, the Fed's investment portfolio, which is nearly $3 trillion, will swell to nearly $4 trillion by the end of 2013 if its bond purchase programs remain fully in place.
The Fed's plan to keep stimulating the economy at least until unemployment has reached 6.5 percent is intended to reassure consumers, companies and investors about the health of the economy, said Joseph Gagnon, a former Fed official who is a senior fellow at the Peterson Institute for International Economics.
Having only a target date of mid-2015 for any increase in interest rates "sounded gloomy," as if the economy would remain weak until then, Gagnon said. Specifying an unemployment rate one close to a normal rate of 6 percent or less makes clear that the Fed will keep supporting the economy even after the job market has strengthened significantly.
"This is trying to get away from that sense of 'Oh, my God, this is all about gloom and doom,' " Gagnon said.
The Fed's new plan to link any rate increase to specific levels of unemployment and inflation mirrors a proposal pushed by Charles Evans, president of the Federal Reserve Bank of Chicago.
Updated forecasts that the Fed released Wednesday illustrate why it thinks it should continue helping the economy. It expects unemployment to remain at least 7.4 percent next year and 6.8 percent by the end of 2014. The earliest it sees unemployment dropping below 6.5 percent is the end of 2015.
It predicts the economy will grow no more than 3 percent next year before picking up to as much as 3.5 percent growth in 2014 and as much as 3.7 percent in 2015.
The Fed said it can pursue the aggressive stimulus programs because inflation remains below its target of roughly 2 percent annually over the long run. The statement said officials think the Fed can keep its benchmark short-term rate near zero as long as its one- to two-year inflation outlook doesn't exceed 2.5 percent.
The statement was approved 11-1. Jeffrey Lacker, president of Federal Reserve Bank of Richmond, objected for the eighth straight time this year. Lacker has said he thinks the job market is being slowed by factors beyond the Fed's control. And he says further bond purchases risk worsening future inflation.
The latest bond-buying program would replace an expiring program called Operation Twist. With Twist, the Fed sold $45 billion a month in short-term Treasurys and used the proceeds to buy the same amount in longer-term Treasurys.
Twist didn't expand the Fed's investment portfolio, it just reshuffled the holdings. But the Fed has run out of short-term securities to sell. So to maintain its pace of long-term Treasury purchases and to keep long-term rates low, it must spend more and increase its portfolio.
The Fed's portfolio totals nearly $2.9 trillion more than three times its size before the 2008 financial crisis.
The Fed has launched three rounds of bond purchases since the financial crisis hit. In announcing a third program in September, the Fed said it would keep buying mortgage bonds until the job market improved substantially.
Skeptics note that rates on mortgages and many other loans are already at or near all-time lows. So any further declines in rates engineered by the Fed might offer little economic benefit.
But besides seeking to spur lending, the Fed's drive to cut rates has another goal: to induce investors to shift money out of low-yielding bonds and into stocks, which could lift stock prices. Stock gains boost wealth and typically lead individuals and businesses to spend and invest more. The economy would benefit.
Inside and outside the Fed, a debate has raged over whether the Fed's actions have helped support the economy over the past four years, whether they will ignite inflation later and whether they should be extended. But within the Fed, so far this year only Lacker has publicly dissented from the Fed's aggressive actions to aid the economy.
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