Fed nearing a plan to clarify direction of rates
Monday, December 12, 2011
WASHINGTON (AP) — The Federal Reserve under Ben Bernanke has gone further than ever to explain its policies to the public. It’s ready to go further still.
A Fed policy meeting Tuesday will likely focus, in part, on an evolving plan to reveal the direction of interest rates more explicitly. The Fed may decide, for example, to regularly update the public on how long it plans to keep short-term rates at record lows.
The new communications strategy could be unveiled as soon as next month.
Most analysts expect no announcements Tuesday about the new strategy or any further steps to try to strengthen the economy. They think the Fed wants to delay any new programs, such as additional bond purchases, to see if the economy can continue the modest gains it’s been making.
Still, the U.S. economy remains vulnerable, especially to the impact of the financial crisis and likely recession in Europe. So the Fed is keeping its options open.
It’s already taken numerous unorthodox steps to try to lift the economy. December, for example, will mark three years since it cut its key rate, the federal funds rate, to a record low of between zero and 0.25 percent.
It’s also bought more than $2 trillion in government bonds and mortgage-backed securities to try to cut long-term rates and lower borrowing costs.
The hope behind both actions was to embolden consumers and businesses to borrow and spend more. Lower yields on bonds also encourage investors to shift money into stocks, which can boost wealth and spur more spending.
One possibility, should the economy worsen, would be for the Fed to buy more mortgage securities. Doing so could help push down mortgage rates and help boost home purchases. The weak housing market has been slowing the broader economy.
The boldest move left would be a third round of large-scale purchases of Treasurys. But critics say this would raise the risk of future inflation. And many doubt it would help much, because Treasury yields are already near historic lows. Unless Europe’s crisis worsens and spreads, few expect another program of Treasury purchases.
Still, it can’t be ruled out.
“Europe is going to be a big headache for quite a while,” said Diane Swonk, chief economist at Mesirow Financial. “We are going to have a lot of icebergs to dodge, and if the situation dramatically deteriorates, the Fed will act.”
On Nov. 30, the Fed joined other central banks in making it easier for banks to borrow dollars. The goal is to help prevent Europe’s crisis from igniting a global panic. The announcement sent the Dow Jones industrial average up nearly 500 points, its best day in 2 1/2 years.
After its September meeting, the Fed said it would re-arrange its bond holdings to stress longer-term maturities, to try to exert more downward pressure on long-term rates.
That followed the Fed’s announcement in August that it planned to keep its benchmark rate at a record low until at least mid-2013. It was the first time it had committed to keeping the rate there for a specific period.
Now, Fed officials are debating how much further to go to signal a likely timetable for any rate changes. Under one option, the Fed would start forecasting the levels it envisions for the funds rate over the subsequent two years. It could publish this forecast, as it now does its economic outlook, four times a year.
Doing so would help assure investors, companies and consumers that rates won’t rise before a specific time. This might help lower long-term yields further — in effect providing a kind of stimulus.
Some worry that such guidance risks inhibiting the Fed’s flexibility to revise interest rates if necessary. Others counter that the Fed wouldn’t hesitate to shift rates if warranted. And they say the benefits of clearer guidance outweigh any constraints it might impose.
“You could make investment decisions with more certainty,” said Mark Zandi, chief economist at Moody’s Analytics.
The Fed is also discussing setting an explicit target for “core” inflation. Core inflation excludes the volatile categories of energy and food. It’s remained historically low — around 1.5 percent by one measure.
Making a specific rate an official goal could anchor inflation expectations and guide investors on when the Fed might adjust rates to try to hit the inflation target.
Stabilizing prices is one part of the Fed’s dual mandate. It’s also supposed to try to maximize employment. One member of the policy committee, Charles Evans, thinks the Fed should set a threshold for unemployment, too — say, 7.5 percent. It would keep rates low until unemployment fell below that level. Unemployment is now 8.6 percent.
Among the Fed’s options for more explicit guidance, many economists say an interest-rate forecast is most likely. A probable time for an announcement would be after the Fed’s Jan 24-25 meeting, when it will update its economic forecasts.
Such a move would follow other steps to make the Fed more transparent that began under Chairman Alan Greenspan and accelerated under his successor, Bernanke.
Not until Greenspan’s tenure did the Fed even announce any changes in its benchmark rate. Until then, financial firms had to study the Fed’s purchases of Treasurys in the bond market to try to determine whether it was raising or lowering rates.
Previous chairmen tended to think the Fed operated best when it could keep financial markets guessing.
“I was there when Arthur Burns was chairman: His motto was, ‘Never tell anybody anything,”’ economist David Wyss said of Burns, who was chairman during the 1970s.
Private economists widely support the Fed’s shift toward more transparency. Most dismiss any concerns that the Fed, by being more open and specific in forecasting rates, might lock itself into wrongheaded policies.
“If we had another financial crisis, people would understand that the Fed would throw their forecast out the window and do what they needed to do,” Zandi said. “I don’t think it hamstrings them in any way.”
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