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Fed links actions to economic markers for first time

Fed chief vows to take action till unemployment drops to 6.5%

The Washington Post

The Federal Reserve will take steps to bolster the economy until the jobless rate falls to 6.5 percent or inflation looks likely to exceed 2.5 percent, the central bank said Wednesday in a historic move that for the first time specifies the Fed’s goals for the economy.

The Fed also said it would buy $45 billion in Treasury bonds a month, on top of $40 billion a month it is already buying in mortgage bonds, in an effort to flood markets with money and reduce interest rates on a wide range of loans. Lower interest rates tend to stimulate borrowing, economic activity and jobs.

The actions signaled the Fed’s concerns that high unemployment — what Fed Chairman Ben Bernanke called “an enormous waste of human and economic potential” — will cast a long shadow over the nation for years. Fed officials projected that the jobless rate, now at 7.7 percent, would not reach 6.5 percent until near the end of 2015 at the earliest.

The economy faces a possible recession if Congress and the White House fail to avert the “fiscal cliff,” an automatic series of deep spending cuts and tax increases for nearly all Americans set to take effect at the end of the year. Negotiations appeared to be at an impasse this week, and some in both political parties have said that allowing the budget cuts and tax hikes to kick in for a short while might be acceptable. But Bernanke used stern language Wednesday to warn against such thinking, adding that while the Fed might take action to stem the damage, its powers would be limited.

“If the economy actually went off the fiscal cliff . . . that would have very significant adverse effects on the economy and on the unemployment rate,” Bernanke said. “We would try to do what we could . . . but I just want to again be clear that we cannot offset the full impact of the fiscal cliff. It’s just too big.”

Bernanke said the risk of going over the fiscal cliff — a term he coined — was already cutting into customer spending and business investment. “The most helpful thing that Congress and [the] administration can do at this point,” he said, “is to find a solution and avoid derailing the recovery.”

It was not clear whether the Fed’s actions would have an immediate effect on the economy. The Fed had already said it planned to take continuous action to boost the recovery until mid-2015. The reaction of financial markets Wednesday was muted. Stock markets ended the day flat.

Bernanke faces a bit of a conundrum. While he speaks gravely of the ill effects of prolonged high unemployment, his ability to take steps to reduce joblessness are constrained. He has to find consensus on the Fed’s governing committee, where many members are nervous about overheating the economy, causing bubbles or inflation.

And Fed policies work in indirect ways. If the Fed’s actions to keep interest rates low, for example, bring down mortgage costs further, it may lead more people to buy homes, which could create construction jobs. But there are many other factors at play. Banks could choose to charge higher rates and make more profit, for example. Or global trade could continue to decline, further weakening the job market.

“If we could wave a magic wand and get unemployment down to 5 percent tomorrow, obviously we would do that,” Bernanke said. “But there are constraints in terms of the dynamics of the economy, in terms of the power of these tools and in terms of the fact that we do need to take into account, you know, the possibility of other costs and risks that might be associated with a large expansion of our (policies).”

Many analysts saw the Fed’s decision to institute specific economic targets as the most important development of the day.

Those targets make clear that the Fed will continue to intervene in support of economic growth until significant improvement is made toward reducing joblessness, or until inflation expectations, as measured by betting in financial markets, meaningfully pick up.

According to leading economic thinking, the Fed’s policies should give businesses and consumers the confidence to borrow and spend money, fueling economic activity.

The Fed’s policy is “particularly likely to help stimulate the economy” and “reduce some of the considerable uncertainty about Fed policy that has resulted from the series of unprecedented actions taken over the past few years,” said Michael Woodford, a Columbia University professor.

The purchases of Treasury and mortgage bonds are more of a continuation of existing policy than an intensification. The Fed had already been buying $45 billion in Treasury bonds and $40 billion in mortgage bonds per month. But the Treasury purchases were set to end this month, and that could have sent a confusing message to the markets at a time when the Fed wanted to signal that it was promoting growth.