Tornado Alley (PROG)

[StephanieVanbryce]

Fed to Hold Rates Down Until Jobless Rate Is Below 6.5%

By BINYAMIN APPELBAUM
December 12, 2012

WASHINGTON — The Federal Reserve said Wednesday that it plans to hold short-term interest rates near zero as long as the unemployment rate remains above 6.5 percent, reinforcing its commitment to improve labor market conditions.

The Fed also said that it would continue in the new year its monthly purchases of $85 billion in Treasury securities and mortgage-backed securities, the second prong of its efforts to accelerate economic growth by reducing borrowing costs.

The announcements continued a policy shift that began in September, when the central bank first made clear that it was focused on reducing unemployment, ending long decades during which inflation was the Fed’s constant priority.

As in September, the Fed sought to make clear that is not responding to evidence of new economic problems, but instead increasing its efforts to address existing problems that have restrained a recovery for more than three years.

“The committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens,” the Fed’s policy-making committee said in a statement issued after a two-day meeting in Washington.

The slow pace of inflation has made the policy shift easier. The Fed said that it expects prices to rise at or below the 2 percent annual pace that it considers most healthy. But the Fed also said that it was inclined to tolerate medium-term inflation as high as 2.5 percent without breaking its focus on reducing the unemployment rate.

The decision to publish economic objectives replaces the Fed’s earlier guidance that it expected interest rates to remain near zero until at least mid-2015. The Fed said, however, that it expected to reach its targets on roughly the same timetable.

The action was supported by 11 members of the committee, led by Chairman Ben S. Bernanke. The only dissent came from Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, who has repeatedly called for the Fed to do less.

The Fed announced in September that it would expand its holdings of mortgage-backed securities by about $40 billion a month until the outlook for the job market showed “sustained improvement.” The central bank also said that it planned to hold short-term interest rates near zero until at least the middle of 2015.

The announcement was the first time that the Fed had tied the duration of an aid program solely to its economic objectives, omitting any end point. The Fed also broke new ground by insisting that the purchases would continue even as the economy began to recover. Both steps were intended to underscore the central bank’s commitment to reducing unemployment, formalizing a shift away from the decades when inflation was its constant priority.

This week’s meeting marked the first test of that commitment. The Fed had announced earlier in the year that it would buy about $45 billion in Treasury securities each month through the end of December. Its September announcement underscored that the two sets of purchases should be considered part of a single effort. So the decision about whether to keep buying Treasuries in the new year stood as the first checkpoint for the promises made in September.

The Fed’s asset purchases are akin to removing seats from a game of musical chairs. Would-be investors in Treasuries and mortgage bonds are forced to compete for the remaining supply by accepting lower interest rates — that is, they are forced to pay upfront a larger share of the money they are entitled to receive as the bond matures.

A number of Fed officials have said in recent weeks that they see clear evidence the new mortgage purchases are reducing interest rates for borrowers. William C. Dudley, president of the Federal Reserve Bank of New York, noted in a recent speech that average rates on 30-year fixed mortgages had fallen by about 0.23 percentage points since September – and even more since the first rumblings in August that the Fed was planning to start buying mortgage bonds.

Indeed, some Fed officials argue that the mortgage bond purchases have a larger impact on the economy than buying Treasuries. The purchases allow the Fed to target interest rates in a critical economic sector. Fed Governor Jeremy C. Stein also argued recently that reducing the cost of mortgage loans has a larger economic impact than reducing the cost of corporate borrowing because people are more likely to take the money that they save and spend it.

But the Fed already is purchasing more than half of the volume of new mortgage securities, leaving little room to expand those purchases without essentially replacing the private market. And by law, the Fed is barred from buying most other kinds of securities. That leaves Treasuries, which are not in short supply, thanks to the federal government’s ever-expanding debts.

The Fed also will publish later Wednesday updated economic forecasts submitted by the members of its policy-making committee. Some of those officials have sounded increasingly upbeat in recent weeks, but they also have repeatedly overestimated the health of the economy and the pace of the recovery.

The forecasts published Wednesday will all be optimistic in at least one respect. They will assume that Congress and the White House reach a deal to avert scheduled tax increases and spending cuts next year.

If not, Fed officials agree that their own efforts will be trivial in comparison to the negative consequences, and that the economy likely will return to recession.


http://www.nytimes.com/2012/12/13/business/economy/fed-to-maintain-stimulus-bond-buying.html?ref=business