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Divided Fed says likely to keep rates low through mid-2013

August 9, 2011 |  1:10 pm

The Federal Reserve on Tuesday sharply downgraded its outlook for the American economy and took the extraordinary step of signaling that it would hold short-term interest rates at exceptionally low levels "at least through mid-2013."

The move marks the first time that the U.S. central bank has pegged a specific timetable to a pledge on its benchmark interest rate, the federal funds rate, which has been near zero since late-2008.

But the decision came with three dissenting votes from Fed committee members, reflecting concerns about the threat of runaway inflation down the road.

The Fed's statement triggered wild swings on Wall Street. Stocks fell initially, but the market rallied toward the closing bell. The Dow index closed up 430 points, or 4%, to 11,239, after plunging 634 points on Monday amid deepening fears about the economy.

Treasury bond yields dived as some investors rushed to lock in longer-term yields in the wake of the Fed's pledge.

Analysts were surprised by the Fed action as most were expecting Chairman Ben S. Bernanke and his colleagues to offer some reassurance about the economic recovery and to make clear that they had the tools and the will to take action if conditions worsened.

But the Fed statement said economic growth this year has been “considerably slower” than expected, with indicators suggesting “a deterioration in overall labor market conditions.”

Pointedly, the Fed committee said it “now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting.” The last meeting was on June 22, when Fed officials said they expected the pace of recovery to pick up over coming quarters.

The weaker economic backdrop, the Fed said Tuesday, was "likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."

Since 2008, the Fed has kept its key rate near zero and has said repeatedly that it would keep it there for “an extended period” -- which Bernanke has said was meant to indicate a period of a few months.

In signaling that it could maintain that rock-bottom rate for at least another two years, the Fed wants to reduce uncertainty for businesses and investors, hoping to give them more confidence to spend and invest.

Fedfisher But the three dissenters on the Fed board showed the split sentiment about whether the Fed should promise more potential stimulus for the economy. Keeping money excessively loose could eventually fuel a surge in inflation, although many economists believe the recovery is too weak to foster significantly higher inflation for now.

Voting against the change in the statement were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser,the heads of the Fed's Dallas, Minneapolis and Philadelphia branches, respectively.

They said they "would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period," retaining the old language.

Fisher, speaking last month, said he believed that the Fed had "already pressed the limits of monetary policy."

Voting for the change were Bernanke, William C. Dudley, Elizabeth A. Duke, Charles L. Evans, Sarah Bloom Raskin, Daniel K. Tarullo and Janet L. Yellen.


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Top photo: Fed Chairman Ben S. Bernanke. Credit: Karen Bleier / AFP / Getty Images 

Bottom photo: RIchard Fisher, head of the Fed's Dallas branch. Credit: Bloomberg News