Federal Reserve poised to keep rates low again, confident in its forecast

By Neil Irwin
Washington Post Staff Writer
Friday, April 23, 2010

Next week, Federal Reserve leaders will gather around a conference table in Washington and will almost certainly decide to keep interest rates at rock-bottom levels, as they have for 11 straight meetings.

The question of when they will change course and start raising rates has immense implications for the economy, and people in financial markets have been parsing every hint from the Fed on when its stance may change. The parsing may not be necessary: The Fed has laid out the conditions that would lead it to reconsider its low rate, and those criteria clearly point toward no hikes anytime soon.

Moreover, by laying out the Fed's three main criteria, the central bank has offered a road map that tells when interest rates may be set to rise.

The Fed's policy of ultra-low interest rates is driven by three economic conditions, spelled out in its recent policy statements: "low rates of resource utilization," or an economy that is producing less than it would if fewer people were unemployed and fewer factories were idle; "subdued inflation trends," meaning that prices are rising very slowly; and "stable inflation expectations," meaning that Americans who are making financial decisions aren't assuming prices will go up rapidly.

The Fed is unlikely to raise rates until at least one of those conditions no longer holds. So Fed watchers would do better to monitor the underlying data on each of those points -- along with the Fed's interpretation -- than obsess over when the central bank will change its statements from saying rates will likely stay low for an "extended period," which has become a parlor game on Wall Street in recent months.

"Policy going forward is going to depend on the data and the Fed's interpretation of the data," said Peter Hooper, chief economist at Deutsche Bank Securities.

On the first of the three conditions, it is clear that the U.S. economy is still functioning well below its potential.

The unemployment rate is 9.7 percent and poised to come down only slowly; Fed leaders, in projections made at their January meeting, expected a jobless rate between 9.5 percent and 9.7 percent at the end of the year, far above the 5 percent or so that would be consistent with an economy operating at full capacity.

Monetary policy operates with a lag, so Fed leaders must make decisions based on their forecast for the future, but the central bank's assessment of the economy is little changed from recent months, and it still forecasts slow growth.

"I last spoke on the economic outlook in October, and my views since then remain largely unchanged," said Donald L. Kohn, the Fed vice chairman, in a speech on April 8. The biggest change to the Fed's economic outlook is that officials are more confident that their forecast of solid but unspectacular growth will prove to be accurate -- the risks of a dip back into recession have declined, but so have the chances of an explosive burst of growth.

New forecasts are set to be released May 19, and these will provide insights from the full range of top Fed officials on the likely path of growth.

The second condition underlying low interest rates is inflation, and here, too, there is little sign of significant price increases. If anything, inflation may be running a little lower than Fed officials might prefer.

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