Fed Signals That a Full Recovery Is Years Away
By BINYAMIN APPELBAUM
Published: January 25, 2012
WASHINGTON — The Federal Reserve said on Wednesday that it was likely to raise interest rates at the end of 2014, but not until then, [B]adding another 18 months to the expected duration of [U]its most basic and longest-running response to the financial crisis[/U].[/B]
The Federal Reserve, under the chairmanship of Ben S. Bernanke, increasingly has offered guidance about its future decisions.
The announcement means that the Fed does not expect the economy to complete its recovery from the 2008 crisis over the next three years. By holding short-term rates near zero beyond mid-2013, its previous estimate, the Fed hopes to hasten that process somewhat by reducing the cost of borrowing.
The Fed said in a statement that the economy had expanded “moderately” in recent weeks, but that unemployment remained at a high level, the housing sector remained in a deep depression, and the possibility of a new financial crisis in Europe continued to threaten the domestic economy.
The statement, released after a two-day meeting of the Fed’s policy-making committee, said that the Fed intended to keep rates near zero until late 2014.
In a separate set of statements, the Fed said that 11 of the 17 members of the committee expected that the Fed would raise interest rates at the end of that period. It noted that the committee expects growth to accelerate over the next three years, from a maximum pace of 2.7 percent this year to a maximum pace of 3.2 percent next year and up to 4 percent in 2014.
This is the first time the Fed has published such detailed predictions by its senior officials about future policy decisions. The Fed’s chairman, Ben S. Bernanke, said Wednesday that he hoped the forecast would stimulate growth by convincing investors that interest rates will remain low for longer than previously expected.
The economic impact, however, is likely to be relatively modest. Investors already expected the Fed to keep rates near zero into 2014, a judgment reflected in the prices of various assets whose values depend on the movement of interest rates.
Moreover, interest rates on many kinds of borrowing already are hovering near historical lows, and pushing rates down gets harder as you approach zero. And tight lending standards make it impossible for many people and businesses to get loans.
“I wouldn’t overstate the Fed’s ability to massively change expectations through its statements,” Mr. Bernanke said at a press conference Wednesday. “It’s important for us to say what we think and it’s important for us to provide the right amount of stimulus to help the economy recover from its currently underutilized condition.”
The new forecast is part of an effort by the Fed to exert greater influence over the expectations of investors to increase the impact of its policies. The Fed can influence current interest rates directly, but its influence over future rates depends on what investors think the Fed will do in the future.
The Fed also issued Wednesday a statement elaborating on its legal mandate to maintain stable prices and to limit unemployment.
The statement said that the Fed aims to increase prices and wages by about 2 percent each year. It is the first time that the Fed has publicly described an inflation target, although its commitment to that goal has been widely understood for years. Mr. Bernanke has long supported a formal inflation target.
The Fed also said that it was equally committed to minimizing unemployment, but that its goal would vary based on economic circumstances. At present, the statement said, it would like the unemployment rate to drop below 6 percent.
The Fed said in a statement that “such clarity facilitates well-informed decision-making by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.”
The economic projections that the Fed released Wednesday show that the central bank expects to meet its inflation goal over the next three years, but that unemployment will remain significantly above its goal.
The Fed said that it expects the economy to expand between 2.2 percent and 2.7 percent this year, a slightly slower pace than its November forecast that growth could reach 2.9 percent. The Fed also reduced its forecast of growth in 2013. It now projects growth of up to 3.2 percent instead of 3.5 percent.
The projections show that most members of the committee expect the economy to gain steam over the next few years, but that the economy still will not be operating at full capacity, so that prices and wages will remain relatively unchanged.
The pace of growth is not fast enough to significantly reduce the number of people who need work. Almost 24 million Americans could not find full-time jobs in December. A major reason that the official unemployment rate has declined in recent months is that many people have stopped looking for work.
[B]The Fed projects that unemployment will drop no lower than 8.2 percent this year, just slightly below the 8.5 percent rate in December, and no lower than 7.4 percent next year. By the end of 2014, the Fed still expects that at least 6.7 percent of people actively interested in working will not be able to find jobs.[/B]
[B]And the housing market remains depressed. Construction of new homes fell to the lowest level on record in 2011, and sales of existing homes were equally scarce despite the availability of mortgage loans at the lowest interest rates in history. Millions of homeowners continue to face foreclosure.
Both the World Bank and the International Monetary Fund recently estimated that the United States will see growth of about 2 percent in 2012, well below the Fed’s estimate, but in line with those of many private forecasters.
Since the beginning of the financial crisis in 2007, the Fed has alternated bursts of activity with periods of rest, several times concluding that it had done enough only to find the economy still struggling to recover.
The Fed announced this summer that the central bank intended to keep interest rates near zero through at least the middle of 2013 and that it would seek to reduce long-term interest rates through changes in the kinds of investments that it holds in its nearly $3 trillion portfolio. Since then, two meetings have passed without the introduction of any new programs.
Some Fed officials have suggested that the Fed should buy mortgage-backed securities, as it did in 2009, to further reduce interest rates on mortgage loans, which already are at record lows. Such a program also could reduce interest rates on other kinds of loans, such as corporate borrowing.
Mr. Bernanke said Wednesday that such purchases remain under consideration, but only “if we see that the recovery is faltering or if we see that inflation is not moving towards target.”
Indeed, the forecasts released Wednesday show that most members of the committee expect to start tightening monetary policy at the end of 2014, even though unemployment will still be quite high.
Mr. Bernanke sought to dispel this implication, however, saying that the Fed would be inclined to increase its stimulus efforts if inflation remained low and unemployment remained high.
“We’re certainly willing to look for different ways to provide further support for the economy if in fact we have this unsatisfactory situation,” he said.
The forecast shows that 11 of the 17 governors and regional Fed presidents expect the Fed to end its policy of holding short-term interest rates near zero by the end of 2014.
The numbers increase steadily with each passing year. Three committee members expect the Fed to raise rates this year and six expect the central bank to do so next year. The median view of the 17 members of the committee is that rates will remain near zero at the end of 2012 and the end of 2013 and will rise to 0.5 percent by the end of 2014.
The forecast is an imperfect window, however, because only 10 members actually hold votes at any given time.
Moreover, the Fed’s chairman exercises outsized authority. The general view of the Fed’s intentions would be sharply altered if it were revealed, for example, that Mr. Bernanke was among the six members expecting rates to remain near zero at the end of 2014. Mr. Bernanke declined Wednesday to provide his own personal forecast.
The actions taken Wednesday were supported by nine members of the committee. Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, dissented.