Federal Reserve considers explicit pledge: Low rates if inflation stays down


Ben S. Bernanke, chairman of the U.S. Federal Reserve, speaks during an open meeting of the Federal Reserve Board. (Bloomberg via Getty Images)
September 23, 2013

The Federal Reserve is leaning toward an explicit commitment to keep interest rates at rock-
bottom levels, as long as inflation remains low.

The pledge would be an attempt to strengthen assurance that the central bank will not tap the brakes on the recovery until it is certain that the momentum can be sustained. The Fed already has vowed not to raise rates — a move that would slow economic growth — at least until the unemployment rate falls to 6.5 percent or inflation rises above 2.5 percent.

It is strongly considering adding a third prong to that promise: not to move if inflation is below a certain target.

“To the extent that we could provide precise guidance, I think that would be desirable,” Fed Chairman Ben S. Bernanke told reporters recently.

But settling on the parameters for that guidance will probably take time and spark heated debate. The Fed attempted to provide similar details on when it would begin winding down a separate stimulus program that pumps billions of dollars directly into the economy each month. But the effort backfired, roiling the markets and prompting investors to doubt the Fed’s word.

“The challenge is that no one, or not even two or three data points, can adequately describe the conditions within the economy,” said Tom Graff, a partner at investment firm Brown Advisory.

Low inflation has added an unexpected wrinkle in the Fed’s support for the economy. When officials began slashing interest rates in the aftermath of the financial crisis, many economists worried that easy money would fuel a spike in prices.

Instead, the opposite occurred, thanks to a lackluster recovery. Prices have risen just 1.2 percent, according to the latest government data. Persistently low inflation breeds fears that money will be worth less in the future, discouraging investment, and makes debt more difficult to pay off. The Fed has targeted inflation to grow by about 2 percent each year, which it said would signal a more robust economy.

Bernanke said last week that low inflation allows the central bank to be “patient” in hiking rates. He called the addition of a minimum level for inflation a “sensible modification” to the Fed’s policy.

“We should be very reluctant to raise rates if inflation remains persistently below target,” Bernanke said.

Other influential Fed officials have expressed similar concerns recently. St. Louis Federal Reserve Bank President James Bullard, a voting member of the policy-setting committee, has repeatedly argued for the Fed to keep its foot on the gas to drive up inflation. Chicago Federal Reserve Bank President Charles Evans, also a voting member, said this month that he would be unlikely to support raising rates if inflation stood at 1.5 percent, even if unemployment fell to the Fed’s target.

But even when Fed officials agree in principle, reaching consensus on specifics can be difficult. Over the past few months, they have sent mixed messages about the future of the stimulus program that involves buying $85 billion a month in bonds to lower long-term interest rates.

Officially, the Fed has tied the program to “substantial improvement” in the job market. But several members of its top banks have tried to clarify what that means — only to later abandon those efforts.

Boston Federal Reserve Bank President Eric Rosengren said the program could slow down once the unemployment rate fell to 7.25 percent, while calling for 200,000 new jobs a month for six months. Bernanke also waded into the fray, proposing an end to bond purchases in the middle of next year, when he expects the jobless rate to be 7 percent.

Those metrics have since fallen by the wayside. The drop in the unemployment rate has been largely because of people leaving the workforce rather than finding jobs. Economic growth has been slower than expected. Markets whipsawed amid investor confusion.

“Transparency is different from communicating clearly,” said Kansas City Federal Reserve Bank President Esther George, who has been a vocal critic of central bank policy, according to news reports. “I am not in favor of promoting transparency without thinking of ways to be clear.”

The confusion over the Fed’s bond purchases is probably one reason the central bank has put off making any changes to its commitment to keep interest rates low. In addition, officials do not expect the recovery to reach either one of their goals until 2015, giving them time for additional discussion.

Bernanke has acknowledged that Fed communication is evolving. The chief architect of its strategy is Fed Vice Chairman Janet L. Yellen, who is expected to take the helm when Bernanke’s term ends in January.

“We need to explain as best we can how we’re going to move and on what basis we’re going to move,” Bernanke said last week. “It’s much more difficult today than it was 20 years ago. . . . But that’s still very important.”

Ylan Q. Mui is a financial reporter at The Washington Post covering the Federal Reserve and the economy.
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