The Fed Cranks Up Its Rhetoric

Federal Reserve rate-setters couldn't cut rates any more, so—in a divided vote—on Jan. 28 they cranked up their recession-fighting rhetoric instead. In ordinary times, the Fed's chief nemesis is inflation. But in a remarkable turn of events, the policymakers hinted that inflation is now actually too low. They said they see "some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term."

The lone dissenter in the Open Market Committee's 8-1 vote to leave rates unchanged was the group's most hawkish member, Jeffrey Lacker, the president of the Federal Reserve Bank of Richmond. But even Lacker wasn't against fighting recession by printing more money. His only objection—at least according to the Fed statement—was that the Fed should increase the monetary base by buying more Treasury securities, rather than through "targeted credit programs." By targeting certain types of assets, such as mortgage-backed securities, commercial paper, and soon auto and student loans, the Fed is meddling more in the workings of the markets than many conservatives feel comfortable with.

Voting for the first time was William Dudley, a former deputy of Timothy Geithner at the Federal Reserve Bank of New York, who became president after Geithner was chosen to be President Obama's Treasury Secretary.

Short-Term Rates You Can Depend On

The Fed couldn't cut its federal funds rate any more because it already cut it to zero at its December meeting—a range of zero to 0.25%, to be precise. That has left the Fed reaching for more unconventional tools. One of them is talk—i.e., making it abundantly clear to the markets that short-term interest rates are going to stay low for a long time to come. Such a conviction tends to bring down long rates as well.

Accentuating the negative on the economy, the Fed said it "anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant." And it repeated its December statement that "weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time."

Lone Dissenter Questions Stategy

The split between Richmond's Lacker and the rest of the board is over what other measures the Fed should take to bring down long-term interest rates. The Fed said it continues to buy "large quantities" of mortgage-backed securities and corporate debt of "agencies," which include the likes of Fannie Mae and Freddie Mac. That's intended to funnel money to the housing market, which is the source of much of the troubles in the financial system and economy. It's also beginning to support consumer and small-business loan markets through a new program called the Asset-Backed Securities Loan Facility. Those are the programs that give Lacker pause. According to the Fed statement, he'd rather see the Fed buying Treasuries, which are obligations of the federal government.

Of course, that doesn't directly help consumers and businesses. On that score, the Open Market Committee said it is prepared to buy longer-term Treasuries "if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets."

Some economists thought the Fed's rhetoric was muddy. The Fed's statement "is a wonderful example of how bad its communications can sometimes still be," wrote Paul Ashworth, senior economist of Capital Economics. He said the Fed offered "a series of cryptic possibilities."

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