Short-term interest rates will remain at rock bottom, the Federal Reserve’s rate-setting committee said today.
The central bank’s Federal Open Market Committee kept the federal funds rate within a range of zero percent to 0.25 percent. The decision was expected. The federal funds rate has been near zero percent since December 2008, and the Fed implied it will remain that low for months more.
With unemployment high and inflation low, conditions “are likely to warrant exceptionally low levels for the federal funds rate for an extended period,” the Fed said.
The central bank added that employers are reluctant to hire, housing starts “are at a depressed level,” and bank lending continues to contract.
One Fed member, Thomas Hoenig, voted against the rate policy, saying that the Fed should stop implying that it will keep the federal funds rate near zero for an extended period.
Banks make overnight loans to one another at the federal funds rate, which influences the prime rate and other short-term rates. Because the Fed left rates unchanged today, the prime rate will stay at 3.25 percent.
The Fed heavily influences short-term interest rates. Market forces — not the Fed — set longer-term interest rates, such as for mortgages and auto loans. The central bank’s influence on long-term interest rates is indirect and unpredictable.
This summer, the Federal Reserve recognized the economy hasn’t grown as fast as central bankers had predicted early in the year. To goose growth, the Fed said it would sprinkle cash into the banking system by buying new Treasury notes as loans underlying its mortgage-backed securities were paid off.
Such an approach is called quantitative easing. It’s a way for the Fed to stimulate spending when the central bank cannot cut the interest rate any further. Like a faucet, quantitative easing can be turned on full-blast or turned down to just a trickle. Lately — with the Fed replacing paid-off mortgages by buying Treasury notes — easing is at a trickle.
But it wasn’t always that way. Last year and into this spring, the Fed sent torrents of money into the economy as it bought more than $2 trillion worth of mortgage-backed securities and Treasury notes. That was an example of quantitative easing with both spigots turned on all the way. Federal Reserve officials have said they could resume a strong course of quantitative easing again if conditions merit it.
“We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial,” Fed Chairman Ben Bernanke said in an Aug. 27 speech. “In particular, the committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.”
In earlier speeches, Bernanke has acknowledged the Fed eventually will have to raise the federal funds rate — but that other actions would come first, such as turning off quantitative easing and increasing the interest rate on deposits that banks keep with the Fed.