The Federal Reserve’s top officials are meeting in Washington this week to decide whether to raise its benchmark interest rate for the first time in nearly a decade. The central bank began cutting the rate in 2007 when it was 5.25 percent and slashed it to all the way to zero during the depths of the financial crisis in December 2008. It has stayed at zero ever since — longer than anyone guessed it would.
During the past seven years, the Fed has continually underestimated how much support the economy needs. Many times, the Fed has suggested that the stimulus, which has come in the form of near-zero rates and $4 trillion in bond purchases, would be fairly limited in scope. As a result, the Fed has almost always had to delay any move that could be seen as withdrawing that stimulus.
There are good reasons for that. The recovery from the Great Recession has been slower and more anemic than anticipated. A large shadow workforce has caused many economists to question how much the drop in unemployment to just 5.1 percent is really a signal of a stronger job market. Inflation has been persistently and puzzlingly weak despite the Fed’s aggressive stimulus.
Fed officials, who say they are driven by economic data, would argue they have acted in a practical way: planning to limit stimulus, but reacting appropriately when the recovery disappointed. Now, the central bank has said it will likely hike rates before the year is over, and this week marks the first real nail-biter meeting. It's worth revisiting their prior statements to see what history can teach us.
“For some time”
The central bank cuts the benchmark federal funds rate to zero for the first time ever. The move put the Fed in uncharted territory, and it was unsure how long it would have to stay there. So it told markets that the target rate would stay exceptionally low “for some time.”
The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.
Nearly three years later, the target rate was still at zero. Lawmakers in Washington passed painful across-the-board spending cuts and flirted with financial disaster with a fight over whether to raise the national borrowing limit. With that backdrop, the Fed said it would leave the target rate untouched at least until “mid-2013.”
The Committee currently anticipates that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013
Just a few months after the Fed committed to mid-2013, it moved the goal even further out.
In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.
At this meeting, the Fed announced it was launching a third round of quantitative easing — massive bond purchases meant to bring down long-term interest rates. In addition, the Fed pushed the earliest potential date of liftoff to mid-2015.
In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.
Until unemployment hits 6.5 percent or inflation rises to 2.5 percent
The Fed switched tactics altogether here. It gave up on trying to forecast a date and instead focused on what the economy would look like at the time of the first rate hike. Or, more specifically, what the economy would NOT look like.
The Fed promised that it would keep the target rate at zero as long as the unemployment rate was above 6.5 percent and inflation was no higher than 2.5 percent. Then-Fed chairman Ben Bernanke was careful to say that these thresholds were not triggers; hitting them only meant the door would open for discussion over whether to hike.
In particular, the Committee decided to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6½ percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. The Committee views these thresholds as consistent with its earlier date-based guidance.
Bonus! Until unemployment hits 5.5 percent
Minneapolis Federal Reserve President Narayana Kocherlakota began arguing in 2012 that the central bank should keep its target rate at zero until the unemployment rate was 5.5 percent. That number was too low for many officials, who worried that waiting that long could spark an unwanted increase in inflation.
But we now know it wasn’t low enough. The unemployment rate stands at 5.1 percent, prices have flatlined, and the target rate is still zero.
Until “well past” the time the unemployment rate hits 6.5 percent
Now we really start splitting hairs. At that time, the unemployment rate was 6.7 percent — within shouting distance of the central bank’s threshold. But the Fed was still unwilling to lower its number. So it adopted this language to signal that it would not move immediately after the unemployment rate dropped below 6.5 percent.
Officials felt the language was needed in part because the Fed also announced at this meeting that it would finally start slowing the amount of money it was pumping into the economy through bond purchases. That was the first baby step toward a rate hike, and officials wanted to reassure investors that the moment was still a long way off.
The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6½ percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.
“A considerable time”
There was considerable debate over what these words actually meant. The unemployment rate would fall below the Fed’s 6.5 percent threshold the next month, and officials knew they needed a new way to describe their commitment to zero.
They decided to link it to the end of their bond purchases, which were slated to be completely phased out by the end of the year. But exactly how long is a considerable time? When asked in a news conference, Fed Chair Janet Yellen suggested it could be six months, give or take a few months. It doesn’t seem unreasonable to say they probably didn’t intend to signal it could take another year — which is how long it’s been since then.
“A considerable time” after the end of the bond purchases actually would have put the first rate hike at roughly … mid-2015. Does that date sound familiar? Fed officials said it was pure coincidence. In any case, we’ve passed that goal line as well.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.
The Fed needed to change its language again once the bond purchases wrapped up. This time, it chose the term “patient” to describe its commitment to a zero rate. Yellen defined “patient” in a news conference as “a couple” of meetings, which most analysts interpreted as two. That means as long as “patient” remained in the Fed’s official guidance, markets could expect no move for at least another two meetings.
Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.
“Further improvement” and “reasonably confident”
It’s been two meetings! Time to move? Not quite.
Officials abandon the term “patience,” but insert yet another qualifier: It must see “further improvement” in the labor market and be “reasonably confident” that inflation will meet the Fed’s 2 percent goal. That means the possibility of a rate hike is technically on the table at every future meeting.
But practically, it's not. In fact, the Fed explicitly stated that moving at its next meeting in April was definitely off the table. The new qualifiers led to new questions about what it would take for the Fed to become “reasonably confident” that inflation will rise, especially amid a sharp run-up in the dollar and a plunge in oil prices. Meanwhile, the unemployment rate continued its steady decline.
The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.
“Some further improvement”
This meeting brings yet another tweak to the Fed’s language, calibrated to indicate that progress is being made in the labor market but that officials aren’t quite there yet. The “reasonably confident” qualifier for inflation, however, remains unchanged.
The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.
We’re now in late 2015 — beyond any calendar date the Fed has provided. The unemployment rate is 5.1 percent — well below the threshold mentioned by any official. And yet the target rate is still zero.
It's impossible to know what would have happened if the Fed had committed in December 2008 to keeping its target rate at zero for the next seven years. Even now, such a promise sounds totally radical, even though that's exactly what ended up happening.
Could that finally change when the Fed wraps up its meeting on Thursday? Perhaps. But it’s also worth noting that Chicago Fed President Charles Evans is now urging the Fed to delay a rate increase.
His new timetable? Mid-2016.