Fed keeps rates low so recovery won't slow

Federal Reserve
  • Steady interest rates help some households and hurt others.
  • New economic issues are creating policy dilemmas for the Fed.
  • Inflation fears could soon change Fed's direction.

Those looking for a loan can borrow with little sorrow, at least for now.

But the pain remains the same for savers.

So decrees the Federal Reserve's rate-setting Open Market Committee, or FOMC. Concluding its meeting today, the FOMC issued the anticipated announcement that it would keep short-term interest rates at their current target rate of close to zero percent.

The FOMC statement suggested it will keep rates low for the foreseeable future. The statement said economic conditions "are likely to warrant exceptionally low levels for the federal funds rate for an extended period."

In addition, in a separate effort to put downward pressure on interest rates, the FOMC voted to continue its "QE2" program. Designed to pump cash into the American banking system through a process known as quantitative easing, "QE2" theoretically will induce lending that, in turn, leads to business expansion and job creation.

The tepid recovery gave the Fed little choice but to stay the course on low rates and "QE2," says Lyle Gramley, a Federal Reserve governor from 1980-85 and current senior economic adviser at Potomac Research Group.

"We still have an unemployment rate of 8.8 percent and a significant slowdown in growth in the first quarter," says Gramley. "So this is not an environment that requires the Fed to start tightening monetary policy now."

According to the press release, "the Committee will regularly review the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability."

When the Fed does decide to adjust holdings, the effect will be one of contraction as opposed to the expansionary policy of purchasing assets. A question for the future may be: Will the Fed adjust its balance sheet before turning to the option of raising interest rates?

While the Fed didn't alter monetary policies, it did break with tradition in one significant way: After today's FOMC meeting, Fed Chairman Ben Bernanke held a press conference, an abrupt departure from his media-adverse predecessor Alan Greenspan. Bernanke says he plans to hold four press conferences per year.

Choppy waters for savers

Experts said the vote to keep the so-called federal funds rate between zero and 0.25 percent -- where it has been since December 2008 -- should mean little change for consumers. But that isn't a good thing for many households, says Bill Hampel, chief economist for the Credit Union National Association. Yields on savings products will remain at historic lows.

"Those consumers who save, which is a big chunk of consumers, especially older households, are still not going to see any relief from this week's (Federal) Open Market Committee meeting on the really paltry yields they're getting on savings account," says Hampel.

For borrowers, the cost of loans will remain low. The prime rate, the benchmark to which many loans are tied, is always 3 percent above the federal funds rate. Traditionally, the Fed lowers interest rates to induce economic activity after a recession. But with rates already near zero, that is no longer an option.

'QE2' sails forward

The inability to cut rates any lower resulted in the Fed's "QE2" program late last year. "QE2" stands for the second round of quantitative easing; "QE1" occurred between 2008 and 2010.

With quantitative easing, the Fed purchases large quantities of U.S. Treasury securities from banks. That, in turn, provides banks a stockpile of capital. The idea is that banks will be so brimming with cash they'll step up their lending.

There has been periodic speculation the Fed would end "QE2" prematurely, but with an expiration date in June, it made no sense for the Fed to back off at this stage, says Mark Thoma, professor of economics at the University of Oregon. "The Fed believes that it's best to keep its word unless significant circumstances force it off its announced path," says Thoma.


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