Federal Reserve sets new targets for interest rates

Ben Bernanke Fed chairman Ben Bernanke said he still expects rates to remain low until 2015

The US Federal Reserve has said it plans to keep interest rates at close to zero at least until the US unemployment rate falls below 6.5%.

The Fed previously had a date-driven target, rather than a data-driven one.

The Fed also said it will continue to buy $85bn (£53bn) a month of government bonds and mortgage-backed securities to try to boost the economy.

But changes in the way it does this will mean more money is pumped into the economy.

"The committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labour market conditions," the Fed said in a statement.

US stocks rose after the announcement. The Dow Jones, which had been little changed before the statement, jumped 70 points to 13,318.

Numerical thresholds

Interest rates in the US have been close to zero for several years now, and the Fed again kept them at below 0.25%.

But in a surprise move, the Fed adopted numerical thresholds for future interest rate policy, something which had not been expected until next year. It said that it expects to keep rates at this exceptionally low range as long as:

  • the unemployment rate remains above 6.5%
  • inflation between one and two years ahead is projected to be no more than a half percentage point above the committee's 2% longer-run goal
  • longer term inflation expectations continue to be well anchored

The Fed had previously said it expected to maintain rates at their current level until 2015.

What is "Operation Twist"?

  • Programme first used by the Fed in 1961 to help stimulate the economy
  • Its nickname comes from both the Twist dance craze of the time and the intended twisting of the yield curve of US debt
  • Involves the Fed selling short-term bonds, causing their interest rate or yield to go up, and buying long-term bonds, causing their yield to fall
  • It does not put any new money into the economy, but aims to keep long-term interest rates low

But in a news conference, Fed chairman Ben Bernanke said the modified formulation did not mean any change in the committee's expectations. It still anticipates holding rates at the exceptionally low range "at least through mid-2015".

Moreover, the stated threshold of 6.5% should not be interpreted as the committee's longer run target for unemployment, which remains at 5.2-6.0%, Mr Bernanke said.

By tying future monetary policy more explicitly to economic conditions, it should make it more transparent, he said.

Increasing portfolio

Under the Fed's current programme "Operation Twist", which expires at the end of the year, the central bank sells short-term bonds in order to buy $45bn a month of longer term bonds.

It does not put any new money into the economy, but aims to keep long-term interest rates down and encourage individuals and businesses to borrow and spend more.

But the Fed has run out of short-term debt to sell, so in order to maintain its pace of long-term Treasury purchases and to keep long-term rates low, it must spend more to boost its portfolio.

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The central bank's latest policy meeting came against the backdrop of the looming "fiscal cliff" - the tax increases and spending cuts due to be implemented in January if Congress and the White House do not strike a deal.

This may have proved a factor in its decision-making as Mr Bernanke said last month that all of the changes would "pose a substantial threat to the recovery".

Fears of the cliff have led some companies to delay investing and hiring, while consumers have also cut back on spending.

The Fed has pledged to keep on bond buying until the labour market outlook improves substantially.

Though the unemployment rate fell to a four-year low of 7.7% in November, statistics suggest that much of the decline in the jobless rate since 2008 has been due to people dropping out of the workforce, either due to retirement or because they have given up seeking work.

The central bank also revised its economic outlook. It now expects the economy to grow between 1.7-1.8% this year and 2.3-3.0% next year.

In September it had forecast growth of 1.7-2.0% in 2012 and 2.5-3.0% in 2013.

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