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Fed to Keep Interest Rate Low Through 2014

The Federal Open Market Committee, the policymaking arm of the Federal Reserve, released their policy statement for January, and it suggests additional monetary accommodation in the years ahead. In fact, it forsees maintaining the extraordinarily low federal funds rate of between 0 and 1/4% until at least the end of 2014. This means that the recovery remains fragile and requires additional monetary aid.

The Fed saw “some slowing in global growth” since its last meeting in December, as well as an elevated unemployment rate in the US, a depressed housing sector and slower growth in business investment. They see a lot of downside risks to the economy, due to “strains in global financial markets,” particularly in Europe. But the main point is that the Fed has a dual mandate on unemployment and inflation, and they see themselves missing both targets – unemployment will be too high and inflation will “run at levels at or below” their mandate. Thus the need for monetary accommodation.

They actually lowered their estimates for GDP growth in 2012, but also lowered their estimates on unemployment. The Fed now sees unemployment between 8.2 to 8.5% by the end of the year. I think we can make sense of this by saying that the Fed does not expect the low labor force participation rate to grow in the coming year. The current 8.5% unemployment rate comes in large measure from that low labor force participation rate, and if it grew, you’d see a higher rate of unemployment.

Here’s the key section of the release:

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.

This was a nearly unanimous vote, and it sets the stage for a QEIII down the road. But I wouldn’t call that policy boldness so much as policy necessity.

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David Dayen

David Dayen