Can you hear me now?
The Fed makes its views loud and clear
JAPAN holds the modern record for years spent with interest rates at zero; they were on the floor from 2001 to 2006. America is on track to break that record. Having cut its short-term rate to near zero in late 2008, the Federal Reserve said on January 25th it will probably stay there “at least through late 2014”, more than a year longer than its previous guidance.
On the same day the Fed for the first time published projections of the year individual members of the Federal Open Market Committee, its main policymaking body, expect the federal-funds rate to start rising and the path it would follow over the next three years. The median forecast for a rise in interest rates is 2014 (see chart) but the accompanying statement implies it will probably be later.
The Fed also took the long-awaited step of announcing an explicit inflation target—something that many other central banks adopted years ago and that the Fed chairman, Ben Bernanke, has long advocated. The central bank said it prefers inflation of 2%, also the target (or the midpoint in a target range) of the British, Canadian, Swedish and Israeli central banks.
Mr Bernanke characterised these steps as a way to make monetary policy more transparent and predictable, and therefore more effective. But the practical consideration is that the Fed needs new ways to kick-start economic growth. Promising lower rates for longer is one way to do this, because it will drive bond yields lower.
Some officials have argued that the Fed could better steer private-sector expectations with a framework that more explicitly committed it to lower unemployment or higher output. The Fed did not go that far but the inflation target (a word the Fed’s official documents didn’t use but Mr Bernanke did in a subsequent press conference) will help in two ways.
First, 2% is at the high end of the range that officials previously considered acceptable. Higher inflation implies lower, and thus more stimulative, real interest rates. Second, markets previously thought the Fed was so focused on inflation that it would tighten as soon as it topped 2%, no matter how high unemployment was. Mr Bernanke dispelled that notion by emphasising the Fed’s equal attention to unemployment. Should inflation overshoot 2% while the economy is unacceptably weak, the Fed will take its time about bringing it back down.
The increased transparency is helping. Since the Fed committed itself in August to two years of near-zero rates, the ten-year Treasury yield has fluctuated around 2% despite a run of better-than-expected economic news. The yield dropped on news of the Fed’s new projections, before rising back up again.
But this flurry of activity still may not be enough. The Fed actually lowered its projections for economic growth to between 2.2% and 2.7% in 2012; it projects growth of 2.8-3.2% in 2013. Unemployment, now 8.5%, is seen edging below 8% only by the end of 2013. Inflation, meanwhile, will be at or below the new target of 2%. With unemployment too high and inflation still weak, more monetary stimulus is easily justified. Mr Bernanke left the door open to that option. The odds are that he will walk through it.
This article is originally published at The Economist