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FILE - This Sept. 13, 2012 file photo shows Federal Reserve Chairman Ben Bernanke speaking during a news conference in Washington. Bernanke said Thursday that banks’ overly tight lending standards may be holding back the U.S. economy by preventing creditworthy borrowers from buying homes. (AP Photo/Manuel Balce Ceneta, File)

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Fed may link low inflation, rates

  • Article by: Ylan Q. Mui
  • Washington Post
  • September 23, 2013 - 6:52 PM

 

– The Federal Reserve is leaning toward an explicit commitment to keep interest rates at rock-bottom levels, so long as inflation remains low.

The pledge would be an attempt to strengthen public assurance that the central bank will not tap the brakes on the recovery until it is certain the momentum can be sustained. The Fed already has vowed not to raise rates — a move that would slow economic growth — at least until the unemployment rate falls to 6.5 percent or inflation rises above 2.5 percent.

It is now strongly considering adding a third prong to that promise: not to move if inflation is below a certain target.

“To the extent that we could provide precise guidance, I think that would be desirable,” Fed Chairman Ben Bernanke told reporters recently.

But settling on the parameters for that guidance probably will take some time and spark heated debate. The Fed attempted to provide similar details on when it would begin winding down a separate stimulus program that pumps billions of dollars directly into the economy each month. But the effort backfired, roiling the markets and prompting investors to doubt the Fed’s word.

“The challenge is that no one, or not even two or three data points, can adequately describe the conditions within the economy,” said Tom Graff, a partner at investment firm Brown Advisory.

Low inflation has added an unexpected wrinkle in the Fed’s support for the nation’s economy. When officials began slashing interest rates in the aftermath of the financial crisis, many economists worried that easy money would fuel a spike in prices.

Instead, the opposite occurred, thanks to a lackluster recovery. Prices have risen just 1.2 percent annually, according to the latest government data. Persistently low inflation breeds fears that money will be worth less in the future, discouraging investment, and makes debt more difficult to pay off. The Fed has targeted inflation to grow by about 2 percent each year.

Bernanke said last week that low inflation allows the central bank to be patient in hiking rates. He called the addition of a minimum level for inflation a “sensible modification” to the Fed’s policy.

“We should be very reluctant to raise rates if inflation remains persistently below target,” Bernanke said.

Other Fed officials have expressed similar concerns recently. St. Louis Fed President James Bullard has repeatedly argued for the Fed to keep its foot on the gas to drive up inflation. Chicago Fed President Charles Evans said this month he would be unlikely to raise rates if inflation stood at 1.5 percent, even if unemployment fell to the Fed’s target.

But even when central bank officials agree in principle, reaching consensus on specifics can be tricky. Over the past few months, they have sent mixed messages about the future of a stimulus program that involves buying $85 billion a month in bonds to lower long-term interest rates.

Officially, the Fed has tied the program to “substantial improvement” in the job market. But several members of the central bank’s regional banks have tried to clarify what that means — only to later abandon those efforts.

Boston Fed President Eric Rosengren suggested that the program could slow down once the unemployment rate fell to 7.25 percent, while Evans called for 200,000 new jobs a month for six months. Bernanke also waded into the fray, proposing an end to bond purchases in the middle of next year, when he expected the jobless rate to be 7 percent.

Those metrics have since fallen by the wayside. The drop in the unemployment rate has been due largely to people leaving the workforce rather than finding jobs. Economic growth has been slower than expected. Markets whipsawed amid investor confusion.

“Transparency is different from communicating clearly,” said Kansas City Fed President Esther George. “I am not in favor of promoting transparency without thinking of ways to be clear.”

The confusion over the Fed’s bond purchases is probably one reason the central bank has put off making any changes to its commitment to keep interest rates low. In addition, officials do not expect the recovery to reach either of their existing goals until 2015, giving them plenty of time for additional discussion.

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