Fed Links Rates to Joblessness, Expands Bond Purchases
The Federal Reserve for the first time linked the outlook for its main interest rate to unemployment and inflation and said it will expand its asset purchase program by buying $45 billion a month of Treasury securities starting in January to spur the economy.
“The conditions now prevailing in the job market represent an enormous waste of human and economic potential,” Fed Chairman Ben S. Bernanke said in a press conference in Washington today after a meeting of the Federal Open Market Committee. The Fed plans to “maintain accommodation as long as needed to promote a stronger economic recovery in the context of price stability,” he said.
Rates will stay low “at least as long” as unemployment remains above 6.5 percent and if inflation is projected to be no more than 2.5 percent, the FOMC said in a statement. The thresholds replace the Fed’s earlier view that rates would stay near zero at least through the middle of 2015.
The move to economic thresholds represents another innovation by Bernanke, a former Princeton University professor and Great Depression expert who has stretched the bounds of monetary policy as he battled the recession and then sought to jolt the world’s biggest economy out of a subpar recovery.
“The Fed has been very active since the crisis began, and they are feeling some time pressure because the longer Americans stay unemployed, the harder it is to incorporate them back into the labor force,” said Dana Saporta, a U.S. economist at Credit Suisse Group AG in New York.
Stocks erased gains as Bernanke said the Fed can’t offset the full impact in case the Obama administration and Congress can’t reach an agreement to avoid automatic tax increases and spending cuts set to take effect next year. The Standard & Poor’s 500 Index was little changed at 1,428.48 at the close of trading in New York after earlier rising as much as 0.8 percent.
Treasuries fell on concern additional bond purchases would fuel inflation. The yield on the 10-year Treasury note rose five basis points to 1.70 percent.
Bernanke said tying the outlook for interest rates to economic variables is a better way to communicate the policy outlook than using a time horizon because markets can “infer how our policies will evolve.”
“If information comes in which says the economy is stronger or weaker than we expected, that would in principle require a change in the date, but it doesn’t necessarily require a change in the thresholds, because that data adjustment can be made by markets just simply by looking at their own forecasts,” he said.
While the FOMC dropped its calendar-based guidance on interest rates, it said the new thresholds are “consistent” with the previous outlook. A majority of Fed officials don’t expect to raise the main interest rate until 2015, when the jobless rate is forecast to fall to between 6 percent and 6.6 percent, according to projections released after the statement.
The bond buying announced today will be in addition to $40 billion a month of existing mortgage-debt purchases. The FOMC said asset buying will continue “if the outlook for the labor market does not improve substantially” and hasn’t set a limit on the program’s size or duration.
The latest move will follow the expiration at the end of this year of Operation Twist, in which the central bank each month has swapped about $45 billion in short-term Treasuries for an equal amount of long-term debt. That program kept the total size of the balance sheet unchanged, while the new purchases will expand the Fed’s holdings.
The decision to embark on outright Treasury purchases doesn’t “significantly” increase the level of monetary stimulus, Bernanke said. The Fed “intends to be flexible” in setting the pace of its asset purchases, and will use “qualitative” criteria to determine the size of its bond- buying program, he said.
FOMC participants today lowered their forecasts for growth next year. They now see the economy expanding 2.3 percent to 3 percent, compared with 2.5 percent to 3 percent in September. Estimates for 2014 are from 3 percent to 3.5 percent, versus 3 percent to 3.8 percent in the previous projection, according to the so-called central tendency of 19 estimates, which excludes the three highest and three lowest.
Fed officials met as the economy showed few signs of reaching the pace of growth needed to put 12 million unemployed Americans back to work. While housing and auto sales have picked up, business spending and exports -- two drivers of the three- year expansion -- have cooled amid slowing global growth.
The world’s largest economy next year is forecast to expand 2 percent, according to the median estimate in a Bloomberg survey of economists, compared with an average of 3 percent in the 10 years through 2007.
“Part of the reason we are engaging in these policies is to try and create a stronger economy, more jobs, so that folks across the country, including places like the one where I grew up, will have more opportunities to have a better life for themselves,” said Bernanke, 58, whose hometown is Dillon, South Carolina.
Three years into the recovery, the 7.7 percent jobless rate remains higher than Fed officials’ estimates for full employment, which range from 5.2 percent to 6 percent. Employers added 146,000 workers to payrolls in November, less than the monthly average of 151,000 this year and the 153,000 in 2011.
Job growth is “still disappointing and still falls short of what they want to see,” Julia Coronado, chief economist for North America at BNP Paribas SA in New York and a former Fed economist, said before today’s statement.
The Fed acted in its last regular meeting of the year as lawmakers and the Obama administration continue talks to avert more than $600 billion of automatic spending cuts and tax increases that threaten to throw the country into a recession.
The so-called fiscal cliff is a “major risk factor” that is already harming investment and hiring decisions by causing “uncertainty” or “pessimism,” Bernanke said. The Fed “doesn’t have the tools” to offset that event, he said.
Inflation expectations climbed after the Fed’s announcement. The break-even rate for five-year Treasury Inflation Protected Securities -- a yield differential between the inflation-linked debt and Treasuries -- rose to 2.1 percentage points from 2.07 points yesterday. That’s a measure of the outlook for consumer prices over the life of the securities. The Fed targets inflation of 2 percent.
Fed purchases of mortgage debt have helped push interest rates on home loans to record lows, spurring a revival in the industry that was at the heart of the financial crisis.
Construction of new houses in October began at the fastest pace since 2008 as builders broke ground on 894,000 units at an annual pace. Prices rose 3 percent from a year earlier in September, according to the S&P Case-Shiller index of home prices in 20 cities.
Lowe’s Cos., the second-largest U.S. home-improvement retailer, has rallied 37 percent this year as consumers spend more on appliances, hardware and tools.
Still, U.S. exports have cooled as a global growth slowdown curbs demand for American goods. That, along with the risk of fiscal tightening in the U.S. next year, has prompted companies to limit capital spending.
With interest rates near zero and an expanded balance sheet, the Fed’s power to address a slowing economy in 2015 may be limited, Bernanke said.
“The ability to provide additional accommodation is not unlimited,” he said. “That is an argument for being somewhat more proactive now and try to get the economy back to a healthy condition.”
Richmond Fed President Jeffrey Lacker dissented for the eighth consecutive meeting, saying he opposed the asset purchase program. Lacker opposed the FOMC’s June decision to extend Operation Twist through the end of the year along with additional asset purchases, saying more bond buying probably won’t quicken economic growth.
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