Federal Reserve Makes its Views Loud and Clear

The median forecast for a rise in interest rates is 2014 but projections imply it will probably be later.

Japan holds the modern record for years spent with interest rates at zero; they were on the floor from 2001 to 2006. America is on track to break that record. Having cut its short-term rate to near zero in late 2008, the Federal Reserve said on January 25th it will probably stay there at least through late 2014, more than a year longer than its previous guidance.

On the same day Federal Reserve for the first time published projections of the year individual members of the Federal Open Market Committee, its main policymaking body. Expect the federal-funds rate to start rising and the path it would follow over the next three years.

Federal Reserve also took the long-awaited step of announcing an explicit inflation target of 2 percent. But Bernanke characterized these steps as a way to make monetary policy more transparent and predictable, and therefore more effective. But the practical consideration is that Federal Reserve needs new ways to kick-start economic growth. Promising lower rates for longer is one way to do this, because it will drive bond yields lower.

First, 2 percent is at the high end of the range that officials previously considered acceptable. Higher inflation implies lower, and thus more stimulative, real interest rates.

Second, markets previously thought the Fed was so focused on inflation that it would tighten as soon as it topped 2 percent, no matter how high unemployment was. Bernanke dispelled that notion by emphasizing the Fed's equal attention to unemployment. Should inflation overshoot 2 percent while the economy is unacceptably weak, Federal Reserve will take its time about bringing it back down.

- Courtesy of The Economist