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Paul Davison USA Today Published 2:00 pm ET Sep 16, 2020 Updated 5:17pm ET Sep 16, 2020
The Federal Reserve said Wednesday that it will likely keep its key interest rate near zero until the economy reaches full employment and inflation runs “moderately” above its 2% goal for “some time,” a vow that economists say is likely to keep rates at rock bottom for the next four to five years.
The central bank made the market-friendly commitment sooner than many top economists anticipated and it drove the Dow more than 150 points higher before the market gave back the gains on persistent tech stock jitters. .
The Fed’s assertion is consistent with its new policy framework unveiled last month, which states that officials will no longer preemptively raise rates as unemployment falls to head off a potential spike in inflation. Rather, the Fed will allow inflation to edge above 2% for a time to make up for years of persistently low inflation and to bolster job gains.
The Fed plans to keep its benchmark short-term rate near zero until “labor market conditions have reached levels consistent with the committee’s assessments of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time,” the Fed said in a statement after a two-day meeting.”
That, the central bank said, will help ensure inflation averages 2% “over time” and the public cam reliably expect 2% price increases.
“These are powerful commitments that we think will support the full recovery as long s it takes,” Chairman Jerome Powell said at a news conference.
Previously, the Fed said it would maintain near-zero rates “until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”
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“The labor market is recovering but it’s a long way — a long way — from maximum employment,” Powell said.
Besides keeping its benchmark rate near zero, new Fed forecasts indicate it likely will stay there at least through 2023, based on policymakers’ median estimate. That’s a year longer than its previous estimate since the Fed’s forecast horizon was extended. But the promise to keep rates near zero until inflation picks up should maintain rock-bottom rates until mid-2024 or possibly longer, says economist Kathy Bostjancic of Oxford Economics.
The Fed now predicts the economy will contract by 3.7% this year, below its 6.5% estimate in June, and the 8.4% unemployment rate will fall to 7.6% by year-end. The Fed previously reckoned the jobless rate would end 2020 at 9.3%.
Yet the economy may be at a crossroads. States are allowing shuttered businesses to reopen, putting furloughed employees back to work and boosting growth. But Congress is deadlocked over a new stimulus to restore enhanced federal unemployment benefits and keep struggling small businesses afloat. The number of permanently laid off workers and bankrupt businesses is rising. And the specter of a second wave of the virus this fall looms.
A look at the Fed’s views on:
Interest rates
All 17 Fed policymakers prefer no hikes from the near-zero federal funds rate through next year and the median projection is for no increases through 2023. But one official believes a quarter-point rate increase will be warranted in 2022 and four think the first move should come in 2023.
Bond purchases
The Fed said its massive bond purchases are now designed partly to juice the economy by lowering long-term interest rates, such as for mortgages, as well as ensure that markets run smoothly. Previously, the Fed said the purchases — of $120 billion a month in Treasury bonds and mortgage-backed securities — were aimed at reviving markets for those assets that virtually came to a halt early in the crisis.
The change eventually could pave the way for the Fed to buy bonds with longer-term maturities to more effectively push down long-term rates.
The economy
Fed officials predict the economy will shrink 3.7% this year, less than their 6.5% forecast in June. But they forecast growth of 4% in 2021, down from their prior 5% estimate, and 3% in 2022.
Gross domestic product plunged at a record 31.7% annual rate in the second quarter, a bit better than the initial 32.9% forecast.
The economy has bounced back faster than expected, largely as a result of stronger consumer spending, Goldman Sachs says. While COVID-19 surges in the South and West led some states to pause or reverse reopening plans, hospitalizations and death tolls have improved recently. IHS Market predicts growth of about 30% in the current quarter.
But Barclays says the recovery is likely to slow in the months ahead, in part because a snap-back in auto production to pre-pandemic levels has played out. Powell noted that many laid-off workers have stopped looking for jobs.
Jobs
Unemployment is projected to fall from the current 8.4% to 7.6% by the end of the year, 5.5% by the end of 2021 and 4.6% by the end of 2022, according Fed officials’ median estimate.
The economy has regained nearly half the 22 million jobs lost in the early days of the pandemic as businesses have reopen but economists say recouping the remainder will be tougher. The number of workers permanently laid off jumped from 2.9 million to 3.4 million in August, indicating some temporary layoffs have become permanent.
Of the 11 million idled workers who have not been called back or found new jobs, Powell said, “Our commitment is not to forget those people.”
Inflation
The Fed estimated its preferred measure of annual inflation will close out 2020 at 1.2%, up from its 0.8% forecast in June, before rising to 1.7% in 2021. A core measure that strips out volatile food and energy items is projected to end the year at 1.5%, above officials’ previous 1% prediction.
Inflation has picked up recently, chiefly because of a surge in used car prices and a partial rebound in apparel prices and air fares that were depressed by the effects of the pandemic.
Even before the crisis, inflation was held down for years by discounted online prices and the globally connected marketplace. The Fed’s new policy framework aims to juice inflation but economists say there’s no guarantee it will work.
While modest price increases are generally a good thing, persistently low inflation can lead to deflation, or falling prices, that prompts shoppers to put off purchases.
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