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Fed to hold rates down until jobless rate is below 6.5 percent

WASHINGTON — The Federal Reserve said Wednesday that it plans to hold short-term interest rates near zero as long as the unemployment rate remains above 6.5 percent, reinforcing its commitment to improve labor market conditions.

The Fed also said it would continue in the new year its monthly purchases of $85 billion in Treasury bonds and mortgage-backed securities, the second prong of its effort to accelerate economic growth by reducing borrowing costs.

The announcements reinforced a policy shift that began in September, formalizing the Fed's commitment to reduce unemployment and breaking with decades during which limiting inflation was the central bank's constant priority.

As in September, the Fed sought to make clear Wednesday that it is not responding to evidence of new economic problems but instead is increasing its efforts to address existing problems that have restrained the recovery for more than three years. The most recent jobless rate, for November, was 7.7 percent.

In separate economic forecasts also published Wednesday, the members of the Fed's policymaking committee made only modest changes to their previous forecasts, published in September, predicting that growth would be slightly slower over the next three years, while unemployment would fall a bit more quickly.

"The committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens," the Fed's policymaking committee said in a statement issued after a two-day meeting in Washington.

The action was supported by 11 members of the committee, led by its chairman, Ben S. Bernanke. The only dissent came from Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, who has repeatedly called for the Fed to do less.

The decision to publish economic objectives replaces the Fed's earlier guidance that it expected interest rates to remain near zero until at least mid 2015. The Fed said, however, that it expected to reach its targets on roughly the same timetable. The economic projections showed that most members of the policy committee expect unemployment to fall below the target of 6.5 percent by the end of 2015.

In the program that ends this month, the Fed sold short-term securities to purchase longer-term securities. In January, it will return to its earlier model of creating money to fund the purchases. That money will be credited to the reserves of banks that sell bonds to the Fed.

The Fed's asset purchases are akin to removing seats from a game of musical chairs. Would-be investors in Treasurys and mortgage bonds are forced to compete for the remaining supply by accepting lower interest rates — that is, they are forced to pay upfront a larger share of the money they are entitled to receive as the bond matures.

A number of Fed officials have said in recent weeks that they see clear evidence the new mortgage purchases are reducing interest rates for borrowers. William C. Dudley, president of the Federal Reserve Bank of New York, noted in a recent speech that average rates on 30-year fixed mortgages had fallen by about 0.23 percentage point since September — and even more since the first rumblings in August that the Fed was planning to start buying mortgage bonds.

Indeed, some Fed officials argue that the mortgage bond purchases have a larger impact on the economy than buying Treasurys. The purchases allow the Fed to target interest rates in a critical economic sector. Fed Governor Jeremy Stein also argued recently that reducing the cost of mortgage loans has a larger economic impact than reducing the cost of corporate borrowing because people are more likely to take the money that they save and spend it.

But the Fed already is purchasing more than half of the volume of new mortgage securities, leaving little room to expand those purchases without essentially replacing the private market. And by law the Fed is barred from buying most other kinds of securities. That leaves Treasurys, which are not in short supply, thanks to the federal government's ever-expanding debts.

The economic forecasts published Wednesday show that Fed officials expect the economy to expand 2.3 to 3 percent in 2013, slightly below the September forecast of growth of 2.5 percent to 3 percent.

7.7 %

Jobless rate for November, the most recent figure.

Fed to hold rates down until jobless rate is below 6.5 percent 12/12/12 [Last modified: Wednesday, December 12, 2012 9:44pm]

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