Friday, February 3, 2012

Fed Watch

The Federal Open market committee concluded its meeting January 25 without any change in short term interest rate policy. They stated that this will continue this policy for three years (2014). A statement of policy three years in advance is unprecedented and it is more likely that this is simply a statement that the Fed sees this policy continuing indefinitely, until economic recovery gains strength. In addition, they have signaled a new round of quantitative easing. This is an aggressive purchase of bonds in an attempt to lower long term interest rates and spur the economy. 

There was more disagreement among the policy makers than usual as six individuals at the meeting expressed a desire for interest rates to begin to increase this year.

Economic growth expectations have been slightly decreased to 2.2% – 2.7% and they believe the recovery faces significant risks. But, inflation seems to be well under control.

While low interest rates are thought to be necessary to encourage investment by business and new housing starts, there is an important negative consequence of the low interest rate policy. Individuals who have saved for retirement and depend upon income for bonds and bank CDs have little or no return on their saving.

It is important to understand that the time period for this policy announcement is very unusual. The assumption that the FED is able to forecast economic conditions far into the future and conduct policy today to have desirable impact in that distant future is questioned by most economists. It is unlikely that the forecasting is that accurate, so we should all place little confidence in the stated policy of no change in interest rate policy for two to three years in the future. Anything beyond late 2012 is at best a guess.

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