Fed: As long as unemployment is high, rates will remain ultra low
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
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
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
"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
What it means for
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
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
"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
"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