Time: Fed’s Announcement Is 'Earth-Shattering'

Friday, 14 Dec 2012 07:57 AM

By Michael Kling

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The Federal Reserve’s announcement to keep short-term interest rates low until the unemployment rate falls below 6.5 percent or inflation exceeds 2.5 percent is more important than many market observers believe.

Indeed, it was “earth-shattering,” according to Time magazine.

For the first time, the Fed put numbers on when it will stop buying bonds and end its quantitative easing commitment to keeping interest rates low.

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

The Fed hopes to convince people to move their money out of low-yielding bank deposits and into riskier, higher-yielding assets, according to Time. If they believe rates will remain low for quite a while, consumers and businesses are more likely to put their money in more economically productive ventures that reduce unemployment.

The Fed's ability to influence expectations of future interest rates through its statements is one of its most powerful tools. "And this is the tool the Fed is leveraging with its recent policy change, and the one it’s been employing with greater intensity for more than a year now," Time notes.

In the summer of 2011, it promised to keep rates low until 2013, and then in January of this year it moved that date to 2014. In September it launched its third round of quantitative easing, saying it would buy $40 billion of mortgage-backed securities a month "for a considerable time after the economic recovery."

Its other tool of buying bonds to drive down rates didn't change much, according to Time, as the Fed will continue “to keep short-term interest rates near zero and attempting to drive down long-term interest rates by purchasing longer-term Treasury securities and mortgage-backed securities at roughly the same pace as the past several months.”

Reuters called the Fed's announcement to tie its actions to specific unemployment and inflation numbers “unprecedented” and “unorthodox.” The Fed hopes the new policy will help financial markets know where its monetary policy is heading, according to Reuters.

"By tying future monetary policy more explicitly to economic conditions, this formulation of our policy guidance should … make monetary policy more transparent and predictable to the public," Fed Chairman Ben Bernanke said at a news conference.

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

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