The Federal Reserve kept short-term interest rates unchanged today. That came as no surprise, so Fed watchers got busy scrutinizing the central bank’s policy statement.
The federal funds rate remains in its range of zero percent to 0.25 percent, and the prime rate remains 3.25 percent. Home equity lines of credit and some credit cards are pegged to the prime rate, and their rates will remain unchanged.
Everyone had expected the rate-setting Federal Open Market Committee to stand pat on the federal funds rate. When the panel last met, six weeks ago, it promised to keep rates at “exceptionally low levels … for some time,” and added that it would “employ all available tools” to promote economic growth.
This time, the panel got more specific. The Fed announced last year that it would buy up to $500 billion worth of mortgage-backed securities to keep mortgage rates low. In today’s rate policy statement, the Fed said that it is ready to spend even more than that — in other words, half a trillion dollars’ worth of mortgage-backed securities might be just the beginning. The goal is “to provide support to the mortgage and housing markets.” The immediate reaction was the opposite of what the Fed intended, as mortgage bond yields went up moderately.
Also in its policy statement, the Fed said it is ready to buy longer-term Treasury notes — an action that should exert a downward push on long-term interest rates. And the panel said the Fed is about to buy securities backed by student loans, auto loans and credit card debt — an action that is intended to make those sorts of loans available to consumers.
The committee’s vote was not unanimous. Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, wanted the Fed to go ahead and start buying Treasury securities now. He voted for an even looser monetary policy than the other eight voting members approved.
The committee expressed a lot of worry about the state of the national and global economy: “Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending. Furthermore, global demand appears to be slowing significantly.”
Although the financial system is stabilizing, credit to consumers and businesses remains “extremely tight,” the Fed said.
The central bank’s economic outlook was bleakly hopeful. Or was it hopefully bleak? The rate-setting panel said it expects a gradual economic recovery to begin this year, “but the downside risks to that outlook are significant.” It added that inflation is expected to remain low — maybe even too low. That is a signal that the federal funds rate is likely to remain near zero for at least the first half of the year, and possibly quite a bit longer.
The Fed reiterated what it said in December: that it “will employ all available tools” to promote economic growth and keep prices from falling or from rising too fast.
Kenneth Thomas, a lecturer in finance at the Wharton School of Business at the University of Pennsylvania, says that, for decades, the Fed had three items in its toolbox: the federal funds rate, the discount rate and reserve requirements. In the last 13 months, the central bank has added eight tools, called facilities. The first was the Term Auction Facility, and the most recently added was the Money Market Investor Funding Facility.
“We’ve gone from three tools to 11 tools and counting, and we can never be sure when he’s going to add a 12th tool,” Thomas says, referring to Fed Chairman Ben Bernanke.
How the tools may help
In counting 11 tools, Thomas isn’t including what he calls “jawboning” and what Bernanke calls “policy communication.” In a speech on Jan. 13 in London, Bernanke explained: “Even if the overnight rate is close to zero, the committee should be able to influence longer-term interest rates by informing the public’s expectations about the future course of monetary policy.” That’s why the Fed said it would keep rates low “for some time.”
Of the new tools that the Fed has created, most of them are intended to keep money flowing from bank to bank. At least two are designed to encourage lending to consumers. The first is the Term Asset-backed Securities Loan Facility, which is supposed to increase the availability of student loans, auto loans and credit cards. In today’s statement, the Fed said this program is just about to start up.
The second tool aimed at consumers comes in the form of the Fed’s plan to buy up to $500 billion in mortgage-backed securities this year. That already seems to have resulted in lower mortgage rates. Now the Fed says it might buy even more than $500 billion of mortgage-backed securities.
This was the first of the rate-setting committee’s eight meetings scheduled for this year.(The next will be on March 17.) Few observers expect any changes in the federal funds rate in the first half of the year.
Facing a slowing economy, the Federal Reserve began to rapidly reduce the federal funds rate 16 months ago. It rapidly slashed the rate from 5.25 percent in September 2007 to 2 percent in April 2008. Then came more cuts in October and December, taking the federal funds rate close to what Bernanke calls the “zero bound.”
Long-term rates, such as those for mortgages, don’t respond directly to the Fed’s short-term rate moves. Sometimes, mortgage rates move in the opposite direction when the Fed reduces the federal funds rate.
The federal funds rate is the target interest rate for banks borrowing reserves among themselves. The discount rate is the interest rate that the Fed charges banks to borrow reserves from the Federal Reserve. The Fed wants to be the lender of last resort: It wants banks to borrow from one another at the federal funds rate before borrowing from the Federal Reserve at the higher discount rate.