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Fed keeps key interest rate low

By Claes Bell, CFA · Bankrate.com
Wednesday, January 25, 2012
Posted: 12 pm ET

The Federal Reserve Open Market Committee today elected to leave rates unchanged and hold off on new quantitative easing, or QE, measures for now.

The key federal funds rate, which determines the rate at which banks lend their balances at the Fed to one another, will remain near zero through late 2014. The federal funds rate influences, directly or indirectly, a vast array of consumer financial products, from savings accounts to credit cards.

Federal Reserve building

Some tentative signs of continued progress for the U.S. economy likely contributed to the Federal Open Market Committee's decision to hold off on additional QE for now.

"People have speculated about QE3 ever since QE2 ended last summer," says Henning Bohn, professor of economics at the University of California, Santa Barbara. "I don't see any prospect of that until we get into a deflationary situation, which threatened when the Fed was announcing QE2. There's really no need."

Bohn says that quantitative easing is primarily a way for central banks to prevent deflation, a downward spiral in prices that can lead to massive unemployment and, ultimately, a long-lasting depression.

"That's a situation when every central bank needs to expand and buy whatever securities they can buy, be it Treasuries or mortgage-backed securities. That's something you do when you have a threat of deflation. That's not on the horizon," Bohn says. "Even with the current flatness in the (Consumer Price Index), we still have headline inflation of 3 percent over the last year."

Add that to some mild good news from the economy, such as a gradually falling unemployment rate, and you have a recipe for a wait-and-see approach from the Fed, Bohn says.

"I don't think we've seen indicators that would suggest that the economy is stalling and the price level is declining, which would force (the Fed) to expand, nor do I think the economy is booming and inflation running away in a way that they would have to contract and counteract," Bohn says.

The biggest news from the Fed meeting may be its unveiling later today of a quarterly rate projection that will track the sentiments of the FOMC members as to when the federal funds rate will increase.

"They've been focused on ways and methods to improve their communication with the public," says Troy Davig, a senior U.S. economist for Barclays Capital based in New York.

Rather than an official prediction of where rates will go in the future, the release will contain "the fed funds path as submitted by each of the FOMC participants," Davig says.

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