Fed: As long as unemployment is high, rates will remain ultra low

By Kelly Dilworth

There's still time to take advantage of today's historically low interest rates.

The Federal Reserve pledged again Wednesday that it won't raise the  federal funds rate target -- which helps set other interest rates -- until the unemployment rate falls below 6.5 percent. (The unemployment rate is currently stuck at 7.8 percent.)

"Information received since the Federal Open Market Committee met in December suggests that growth in economic activity paused in recent months, in large part because of weather-related disruptions and other transitory factors," said the Fed in a post-meeting statement. "Employment has continued to expand at a moderate pace but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has shown further improvement."

In light of the improving but still weak economic data and relatively stable outlook for inflation, members of the Federal Open Market Committee (FOMC) voted to leave the federal funds rate target -- which helps set the rate at which banks trade Federal Reserve Bank balances -- at 0 percent to 0.25 percent.

The same day the Federal Reserve announced that it is leaving its interest rate policy alone, for now, the Commerce Department said that gross domestic product (GDP) in the U.S. contracted toward the end of 2012 for the first time since 2009. The negative growth was largely due to substantial cutbacks in defense spending and fewer investments in inventory made by businesses, said the Commerce Department. 

The dual reports underscore the enduring weakness of the U.S. economy, which experts say has captured the Fed's attention to such a degree that the Fed is trying to use nearly every power it has to help the economy recover. 

"They're doing all they can," says Don Dutkowsky, a professor of economics at the Maxwell School of Citizenship and Public Affairs at Syracuse University. "They're not overly worried about inflation at this point and they're trying to get this slow growing economy back to a complete state of health."

What it means for borrowers
As a result, interest rates on everything from home loans to credit cards are going to remain at record lows for some time.

Most credit cards in the United States, for example, are tied to the U.S. prime rate, which is typically 3 percentage points above the federal funds rate. When the  Federal Open Market Committee (FOMC) votes to raise or lower the federal funds rate target, the  U.S. prime rate moves up or down as well.

The Federal Reserve hopes that by keeping interest rates at historic lows, businesses and consumers will take advantage and borrow more than they otherwise would.

The policy's success, however, has been mixed, say experts. Consumer spending and business spending have both picked up somewhat in the past year. So have the housing and auto markets. However, growth remains slow -- and often unsteady -- and is not yet strong enough to push the U.S. toward the robust recovery the Fed is aiming for.

 "The economy needs more spending," says Dutkowsky. "But it's a lot to expect of businesses to undertake the burst of economy activity," that the economy needs to reach a substantially lower unemployment rate.

Many consumers and small businesses are also facing a historically tight credit market that makes it tough for many people to take advantage of the low-rate loans that are available to some, even if they wanted to, says Rebel Cole, a professor of finance at DePaul University.

"Banks simply aren't lending, except to the most creditworthy customers," says Cole. Some banks have eased their underwriting standards somewhat in the past year, according to Federal Reserve data. However, most have reported to the Fed that they are making few, if any, changes to the tight credit standards they implemented during the recession.  

"It has a huge impact," says Cole. "If firms can't borrow, they can't expand. If they can't expand, they can't hire. Until the banks start lending, you can't jump-start the labor market."

At the same time, many consumers are being hampered by the tighter credit standards and aren't able to make the big ticket purchases they'd otherwise make if they had access to the record low rates that are being offered to people with pristine credit, says Cole.

"What you sort of have is this catch-22," he says. "Until consumers start buying, businesses won't expand." But often what happens is, "consumers aren't buying because banks aren't lending." 

Experts expect more of the same
Despite the structural roadblocks that are making it difficult for the Fed's policies to work as well as the committee hopes, experts say that the Fed is unlikely to give up anytime soon. Experts predict that the Fed will continue focusing on trying to lower the unemployment rate as long as inflation remains stable. 

"The Bernanke Fed has clearly been aggressive in terms of trying to expand this economy and get it to recovery and they continue to be so," says Syracuse University's Dutkowsky. Absent any wild card, such as unusually higher prices, the Fed is likely to stay the course until the unemployment rate hits the Fed's target number, he says.

That, in turn, could take some time, say experts. The unemployment rate "has been distorted by people giving up and leaving the labor force," says DePaul University's Cole. "The labor market really hasn't improved much at all since the worst of the financial recession and that's really why the Fed has been concerned."

See related: Why your traditional credit score is becoming obsolete

Published: January 30, 2013

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