Will the Fed keep its low interest rate promise?
October 14, 2011
Q: Do you think Ben Bernanke will really keep interest rates low for two years as he has stated?
A: Two years is an awfully long time to try to foresee how the economy will grow and whether inflation will stay in line, let alone account for the random shocks that can sometimes force policy changes.
Why would the Fed make such an unusual commitment? Because it is running out of tools. After all, with the federal funds rate having been near zero for more than two years, simply issuing the usual statement about keeping rates low until the next meeting would have had limited impact. Remember, the Fed's statement was made at a time when the financial markets were reeling from the debt-ceiling fiasco. So the Fed found a way to get more mileage out of the status quo by committing to it for an unusually long time.
Can the Fed keep that promise? It's not a sure thing. Here is one argument for, and two against, the likelihood of federal funds rate staying near zero for another two years:
- For: The economy really is that sluggish. Is it possible to envision it being this sluggish for another two years? Unfortunately, yes.
- Against: Inflation has been gaining momentum all year. If this continues, the Fed will be forced to respond with higher interest rates.
- Against: Federal funds rates this low are already unprecedented. Betting on this to continue is a bet against history.
Unfortunately, low interest rates are not a cost-free policy. People with CDs, savings accounts, and money market accounts are suffering, and can expect this to continue for at least a while longer. Still, while it may seem that the Fed has handcuffed its ability to make policy adjustments going forward, its commitment to low interest rates is not binding in any way. Expect the Fed to abandon it if conditions dictate.
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