Fed details plan to keep rates low

WASHINGTON – The Federal Reserve sent its clearest signal to date Wednesday that it will keep interest rates super-low to support the U.S. economy even after the job market has improved significantly.

The Fed said it plans to keep its key short-term rate near zero until the unemployment rate reaches 6.5 percent or less – as long as expected inflation remains tame. Unemployment is now 7.7 percent.

That plan adds detail to what the Fed had said before: that it expects to keep the rate low until at least mid-2015. For the first time, the Fed is making clear to investors and consumers that it will link its actions to specific economic markers.

“This approach is superior” to setting a timetable for a possible rate increase, Chairman Ben Bernanke said at a news conference. “It is more transparent and will allow the markets to respond quickly and promptly to changes” in the Fed’s economic outlook.

Bernanke made clear that even after unemployment falls below 6.5 percent, the Fed might decide that it needs to keep stimulating the economy. Other economic factors will also shape its policy decisions, he said.

“The Fed has become more explicit and more transparent,” said Steven Wood, chief economist at Insight Economics. “This should provide the markets with much more clarity around monetary policy action in the upcoming year.”

In a statement after its final policy meeting of the year, the Fed said it will also keep spending $85 billion a month on bond purchases to drive down long-term borrowing costs and stimulate economic growth.

The Fed will spend $45 billion a month on long-term Treasury purchases to replace a previous bond-purchase program of an equal size. And it will keep buying $40 billion a month in mortgage bonds.

Those purchases, and the Fed’s commitment to low rates, are intended to spur borrowing and spending in an economy still growing only modestly 3 1/2 years after the recession ended.

Still, Bernanke warned that none of the Fed’s actions could outweigh the economic pain that would be caused by sharp tax increases and government spending cuts that are set to kick in next month. The standoff between President Barack Obama and Republican lawmakers over how to resolve the “fiscal cliff” is already hurting the economy and threatens to push it into a recession next year, he said.

Fed policymakers are hopeful that the crisis can be resolved without significant long-term economic damage, Bernanke said. They foresee slightly faster growth next year and a gradual decline in unemployment.

Bernanke’s comments about the impact of the fiscal cliff seemed to raise some concern among investors. Stocks had risen after the Fed’s statement was released. But by the end of Bernanke’s news conference, market averages were mixed. The Dow Jones industrial average closed down about 3 points. The Standard & Poor’s 500 index rose fractionally.

With its new purchases of long-term Treasurys, the Fed’s investment portfolio, which is nearly $3 trillion, will swell to nearly $4 trillion by the end of 2013 if its bond purchase programs remain fully in place.

The Fed’s plan to keep stimulating the economy at least until unemployment has reached 6.5 percent is intended to reassure consumers, companies and investors about the health of the economy, said Joseph Gagnon, a former Fed official who is a senior fellow at the Peterson Institute for International Economics.

Having only a target date of mid-2015 for any increase in interest rates “sounded gloomy,” as if the economy would remain weak until then, Gagnon said. Specifying an unemployment rate – one close to a normal rate of 6 percent or less – makes clear that the Fed will keep supporting the economy even after the job market has strengthened significantly.

“This is trying to get away from that sense of ‘Oh, my God, this is all about gloom and doom,’ ” Gagnon said.