Federal Reserve to continue asset purchase program & keep interest rates near 0%

Federal Reserve Chairman Ben Bernanke on Sept. 18, 2013. SOURCE: FederalReserve.gov

The Federal Reserve last week announced that it will keep interest rates between 0% to 0.25% and continue to purchase about $45 billion in longer-term Treasury securities and $40 billion in agency mortgage-backed securities per month to “put downward pressure” on borrowing costs, “support mortgage markets”, and “promote a stronger economic recovery”.

The Fed’s decision to extend the asset purchases was a surprise to many investors, who were expecting the Federal Open Market Committee [FOMC] to begin phasing out the securities purchases later this year. In June, the FOMC, citing the “improvement in the outlook of the labor market”, indicated that it would likely end the asset purchase program by mid-2014.

However, citing the still “elevated” unemployment rate of 7.3% and indications of financial and fiscal headwinds that might hamper the economic recovery, the Federal Reserve decided to continue its “highly accommodative policies” for the time being.

“The committee has some concern that the rapid tightening of financial conditions in recent months could have the effect of slowing growth…a concern that wold exacerbated if conditions tighten further,” said Bernanke. “The extent of the effects of restrictive fiscal policy remain unclear and upcoming fiscal debates may involve additional risks to financial markets and to the broader economy. In light of these uncertainties, the committee decided to await more evidence that the recovery’s progress will be sustained before adjusting the pace of asset purchases.”

Bernanke emphasized that while there have been some “moderate” improvements to the economy and labor market, he said the 7.3% unemployment rate is “well above acceptable levels” and pointed out that there has been a drop in labor force participation even while long-term unemployment and under-employment rates remain high.

Bernanke said the Federal Reserve will maintain the “exceptionally low range to the fund’s rate” of 0% to 0.25% “as long as the unemployment rate remains above 6.5%”. He noted that most of the FOMC participants “expect the first rate increase to take place in 2015”.

“Most participants also see the funds target rate rising only very slowly after the process of removing policy accommodation begins. The median projected funds rate for the end of 2015 is 1%,” said Bernanke. “And notably, although the central tendencies of projections of both inflation and the unemployment rate in 2016 are close to the longer-run normal values of those variables, the median projection for the federal funds rate at the end of 2016 is 2%, well below the longer-run normal value for the federal funds rate of 4% or so.”

Federal Reserve projections – Sept. 18, 2013:

  • Economic growth will range from 2.0% to 2.3% in 2013, rising to 2.9% to 3.1% in 2014, and reaching 2.5% to 3.3% in 2016.
  • Unemployment rate will drop down between 7.1% to 7.3% in 2013, 6.4% to 6.8% in 2014, and 5.4% to 5.9% in 2016, which Bernanke pointed out is “about the longer-run normal level for the unemployment rate”.
  • Inflation will increase between 1.1% to 1.2% in 2013, 1.3% to 1.8% in 2014, and 1.7% to 2.0% in 2016. (The Fed’s target inflation rate is 2.0%.)

 

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