WASHINGTON – When the Federal Reserve meets this week, it’s likely to affirm a message it intends to help lift the U.S. economy: that consumers and businesses will be able to borrow cheaply well into the future — even after unemployment has dropped sharply.
Last month, the Fed signalled for the first time that it will tie its policies to specific economic barometers. It said that as long as the inflation outlook is mild, it could keep short-term rates near zero until unemployment dips below 6.5 per cent from the current 7.8 per cent.
That could take until the end of 2015, the Fed predicted last month.
The Fed’s guidance was designed to give consumers, companies and investors a clearer sense of when super-low borrowing costs might start to rise. Though some key sectors of the economy are improving, analysts think the Fed still feels more time is needed for low rates to spur borrowing, spending and economic growth.
One reason is that many Americans remain anxious about the budget impasse in Washington.
“The Fed is dealing with a lot of uncertainty right now, with all the decisions still to be made on federal budget policy,” said Diane Swonk, chief economist at Mesirow Financial, who expects the Fed to make no changes in its support programs when its two-day policy meeting ends Wednesday.
At its December meeting, the Fed said it would keep spending $85 billion a month on bond purchases to keep long-term borrowing costs down. It will continue its bond purchases until the job market improved “substantially.”
When it buys bonds, the Fed increases its investment portfolio and pumps more money into the financial system — something critics say could eventually ignite inflation or create dangerous bubbles in assets like real estate or stocks.
On Friday, when the government will release its jobs report for January, unemployment is expected to remain 7.8 per cent. That still-high rate, 3 1/2 years after the Great Recession officially ended, helps explain why the Fed has kept its key short-term rate at a record low near zero since December 2008, just after the financial crisis erupted.
In a speech in Ann Arbor, Michigan, this month, Chairman Ben Bernanke said he thought too little progress had been made in reducing unemployment and signalled that the Fed’s aggressive support programs should continue.
“There is still quite a ways to go,” Bernanke said of the unemployment crisis. “There are too many people whose skills and talents are being wasted.”
Still, some private economists think the Fed will decide to suspend its bond purchases in the second half of this year. They note that the minutes of the Fed’s December meeting revealed a split: Some of the 12 voting members thought the bond purchases would be needed through 2013. Others felt the purchases should be slowed or stopped altogether before year’s end.
On one point, economists agree: Once the Fed does decide to scale back its stimulative policies, it will signal its intent well before it actually does so. Policymakers will want to blunt the shocks that could reverberate through financial markets, which have been heavily influenced by the loose-credit policies the Fed has engineered for more than four years.
Interest rates have sunk to record lows. And stock prices have risen as many investors have shifted money into the stock market in search of better returns.
“Nothing will change at this meeting, but as time goes on, I think the Fed will begin laying the groundwork for changes,” said Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University.
Once the Fed does tighten its interest-rate policy, it will inevitably jolt the markets, however much it tries to ease the impact, predicted David Jones, chief economist at DMJ Economic Advisors.
“The second the Fed gives a hint that they are in any way being less accommodative, we will see interest rates shoot higher and stock prices fall,” Jones said.