Federal Reserve leaves key interest rate unchanged

The Federal Reserve left its target interest rate near zero and will continue winding down its unconventional programs, the central bank said Wednesday -- though there were new signs of internal disagreement about how much longer to continue its extreme efforts to support the economy.

Following a two-day policymaking meeting, the Fed said the weak economy and subdued inflation "are likely to warrant exceptionally low levels" for interest rates "for an extended period." It also said it will follow through with plans to end a $1.25 trillion program to support the mortgage market by the end of March, and taper off other special lending programs by Feb. 1.

The Fed's comments helped turn around major stock indexes that were down earlier in the day. The Dow Jones industrial average finished the day up 0.4 percent after being down by about the same amount before the statement. The Standard & Poor's 500-stock index climbed 0.5 percent, and the Nasdaq composite index rose 0.8 percent.

The year's first monetary policy meeting came at a sensitive time for the Fed, as Chairman Ben S. Bernanke awaits a Senate confirmation vote for a second term. Senate leaders intend to hold a procedural vote Thursday, in which Bernanke will need 60 ayes, followed by a confirmation vote as soon as Friday in which he will need 51 ayes to get four more years as Fed chairman when his term expires Sunday.

At least one Fed official at Wednesday's meeting of the Federal Open Market Committee appears inclined to press even more aggressively to remove the central bank's policies that support economic growth. Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City, Mo., dissented from the decision, arguing that "conditions had changed sufficiently" -- meaning that the economy now appears sufficiently stable -- that the Fed should no longer promise to keep rates low for an extended period.

The dissent represents yet another step toward stopping the extraordinary efforts it put in place amid the financial crisis and recession. While the Fed has moved steadily to end its unconventional programs, it has left its main policy tool -- its target for the federal funds rate, a bank lending interest rate -- at a range of zero to 0.25 percent since December 2008. After each policymaking meeting since then, the Fed has signaled that it probably would leave the rate there for "an extended period."

Some Fed leaders, apparently including Hoenig, worry that this language is causing financial markets to anticipate a vast flood of money from the Fed for the indefinite future, and that this could risk causing inflation to take off and potentially fuel bubbles in the stock market and other assets. Hoenig, the longest serving of the 12 presidents of regional Fed banks, has argued that the Fed left interest rates too low during the 2003-2004 period, contributing to the housing bubble and inflation that followed.

"The dissent doesn't mean they're going to raise rates soon, but it does continue to push them down the road in that direction a bit," said John Canally, an economist with LPL Financial in Boston.

Hoenig's was the first dissent at a Fed policymaking meeting in a year, and reflects that he has now become a voting member of the Federal Open Market Committee. He and other regional Fed bank presidents rotate voting spots on the panel, starting with the January meeting.

But the majority of the committee views the economy as too weak -- and the inflation threat too distant -- to even think about raising interest rates in the near future.

"I doubt the Fed will raise rates as long as the unemployment rate is anywhere near 10 percent," said Victor Li, an economist at the Villanova School of Business. "This language about keeping rates low for an 'extended period' is not well defined, but if economic conditions change dramatically, in terms of growth, employment or inflation, they would move pretty quickly to reverse themselves."

In its exit strategy, the Fed declined to take a more concrete step that analysts expect in the coming months: raising the amount that banks must pay to take out emergency loans at the Fed's "discount window."

Before the financial crisis began in 2007, that rate was a full percentage point above the more widely followed federal funds rate, a gap that the Fed narrowed to help address the financial crisis. At some point the Fed probably will increase the discount rate, now at 0.5 percent, reflecting that the financial crisis is over, a step that would not flow through to borrowing costs across the economy and restrain growth.