Tags: fed | easing | unemployment | rate

Fed Links Rate Hike to 6.5% Unemployment, Pumps More Money Into Economy

Wednesday, 12 Dec 2012 12:34 PM

 

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In an unprecedented step, the Federal Reserve said on Wednesday it would hold interest rates near zero until it hit the specific target of a 6.5 percent U.S. jobless rate, and it pledged to keep pumping more money into the economy.

The central bank said its commitment to hold rates steady until its new threshold was reached would hold as long as inflation was projected to be no more than 2.5 percent one or two years ahead and inflation expectations were contained.

The decision, accompanied by an announcement to replace a more-modest and expiring stimulus program with a fresh round of Treasury debt purchases, came as a surprise. Most economists had not expected the central bank to adopt thresholds to guide policy until sometime next year.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

"The committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions," the Fed's policy-setting panel said in a statement.

Fed officials committed to monthly purchases of $45 billion in Treasuries on top of the $40 billion per month in mortgage-backed bonds they started buying in September, as financial markets had expected.

Under the "Operation Twist" program that will expire at the end of the month, the Fed was buying $45 billion in longer-term Treasuries with proceeds from the sale of short-term debt. The new round of government bond-buying it announced on Wednesday will be funded by essentially creating new money, further expanding the Fed's $2.8 trillion balance sheet.

Fed policymakers voted 11-1 to back the new plan. Richmond Federal Reserve Bank President Jeffrey Lacker dissented, as he has at every meeting this year, expressing opposition both to the bond buying and the new economic thresholds.

Stocks added to earlier gains and long-term government bond prices fell on the Fed's announcement. Fed Chairman Ben Bernanke will discuss the central bank's latest decision at a news conference at 2:15 p.m. (1915 GMT).

"They see an anemic economy, and they're doing all they can to get any economic progress," said Alan Lancz, president of Alan B. Lancz & Associates in Toledo, Ohio.

In its statement, the Fed noted unemployment remains elevated and that inflation is running somewhat below the central bank's 2 percent objective.

Policymakers repeated a pledge to keep buying bonds until the labor market outlook improved substantially, although they said their long-term asset purchase program would end well before they raise rates.

A drop in the jobless rate to 7.7 percent in November from 7.9 percent in October was driven by workers exiting the labor force, and therefore did not come close to satisfying that condition.

SWEATING A WEAK RECOVERY

The Fed cut overnight rates to near zero in December 2008 and has bought about $2.4 trillion in bonds in a further effort to push borrowing costs lower and spur a stronger recovery.

Despite the unconventional and aggressive efforts, U.S. economic growth remains tepid. GDP grew at a 2.7 percent annual rate in the third quarter, but it now appears to be slowing sharply. According to a Reuters poll published on Wednesday, economists expect the economy to expand at just a 1.2 percent pace in the current quarter.

Businesses have hunkered down, fearful of a tightening of fiscal policy as politicians in Washington wrangle over ways to avoid a $600 billion mix of spending reductions and expiring tax cuts set to take hold at the start of 2013.

Bernanke has warned that running over this "fiscal cliff" would lead the economy into a new recession.

By setting thresholds to guide its decision on when to eventually hike rates, the Fed was able to jettison a previous prediction that borrowing costs would remain at rock bottom levels until at least mid-2015.

Officials were uncomfortable giving guidance on monetary policy based on a calendar date, and are hopeful the new framework will help financial markets assess incoming economic data in a way that helps them correctly gauge the likely future stance of policy.

The prior policy of fixing an end point was criticized by some economists as sending a message that the Fed expected the economy to be weak until then.

In economic projections released in September, the Fed suggested the jobless rate would not fall to 6.5 percent until late-2015.

Fed officials will release a new set of economic and interest rate projections at 2 p.m. (1900 GMT) that could show yet another round of downward revisions to growth prospects.

Back in September, the Fed predicted the U.S. economy would expand 2.5 percent to 3 percent in 2013, but even that modest rate is looking potentially rosy. The Reuters poll showed a median U.S. growth estimate of 2.1 percent for next year on the same fourth quarter over fourth quarter basis.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

© 2014 Thomson/Reuters. All rights reserved.

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