Explainer: What did the Federal Reserve promise?

Federal Reserve seal on $100 bill

STEVE CHIOTAKIS: Interest rates will remain near zero for the next two years, until 2013. At least that's what the Federal Reserve promised yesterday in its regular statement. Keeping rates that low for that long is unprecedented -- and it's a huge promise -- so can we take that promise to the -- central bank?

Marketplace's Jeff Horwich joins me to talk about that.

JEFF HORWICH: Good morning, Steve.

CHIOTAKIS: So, what exactly did the Fed promise to do?

HORWICH: Well, let's look at the actual language. The Fed's announcement says economic conditions, quote, "are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013." That actually sounds like plenty wiggle room. But ING chief economist Mark Cliffe is worried investors are indeed taking the Fed's statement as some kind of promise.

MARK CLIFFE: This is their current assessment. This is not a cast-iron guarantee that interest rates are going to remain at zero for the next couple years -- that's the wrong way to interpret it.

HORWICH: So, let's say the economy gets better faster than we think. One possibility is the Fed changes its mind -- has to go back on its word, raise rates to reign in inflation. Another risk is that the Fed feels it can't change its mind, and lets the economy overheat.

CHIOTAKIS: Wiggle room, as you say. This could just be a first step from the Fed, right, and the economy still needs more help -- what else could it do?

HORWICH: The Fed has hinted at another round of quantitative easing -- the Fed buying bonds to inject money into the economy. But many economists like Scott Sumner of Bentley University think the Fed can get even more specific in the promises department.

SCOTT SUMNER: An explicit promise to hit some say inflation or price level target at a series of future dates I think would have a much more powerful effect on expectations because it would tell the markets that the Fed is going to do whatever it takes to meet its goals.

HORWICH: Now Sumner says that may be asking a lot of a usually pretty circumspect institution -- but these are pretty extraordinary times.

CHIOTAKIS: Marketplace's Jeff Horwich, reporting live for us. Jeff, thanks.

HORWICH: You're welcome.

Comments

I agree to American Public Media's Terms and Conditions.
With Generous Support From...