Are Continued Low Interest Rates Boosting the Economic Recovery?

The Fed is maintaining its policies, but the effects on the job market may be minimal.

Bernanke_120327_01.jpg
By SHARE

Wednesday revealed more of the same from the Federal Reserve, with the central bank's Open Market Committee maintaining a cautious tone about the recovery and reiterating that it's likely to hold interest rates near zero through at least late 2014.

[What's driving Gen Y's buying patterns?]

"[T]he Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions ... are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014," the committee said at the conclusion of its April meeting.

The Fed has held interest rates near zero since December 2008, but in January, it began issuing guidance about future interest rates. The reason for the Fed holding the line on these policies is a middling recovery. Maintaining low interest rates—with plans to do so for some time—can provide both stimulus and stability.

"In a cyclical context, lower rates should stimulate more investment and more spending, because it's cheaper to borrow and do those things," says Patrick O'Keefe, director of economic research at J.H. Cohn.

Meanwhile, setting expectations for future interest rates minimizes the likelihood of surprises.

"What they wanted to do by [putting a time frame on low interest rates] was get doubt out of people's heads so they can plan," says Frank Fantozzi, CEO of Planned Financial Services, Cleveland-based independent wealth management company.

The decision to maintain policies comes amid a recovery that is neither robust nor anemic.

The U.S. economy has come a long way since December 2008. Unemployment climbed to 10 percent, but has since dropped to 8.2 percent. GDP growth has gone from deep in the negatives to a measured, positive pace. These improvements seem to mitigate any need for a third round of massive bond buys, also known as "QE3,” though Federal Reserve Chairman Ben Bernanke said during today’s press conference that the option “remains very much on the table,” should conditions warrant it.

[See why it's not time to panic yet on Social Security.]

Then again, housing prices continue to fall, and job growth is uneven. Federal Reserve Chairman Ben Bernanke has said he sees job gains as puzzling, telling the National Association of Business Economics conference last month that economic growth does not explain the recent decline in the unemployment rate.

Likewise, the Fed’s projections are neither altogether positive nor negative. According to the committee’s “central tendency” estimates, which exclude members’ three highest and lowest predictions, the committee has slightly improved its 2012 GDP growth forecast since January, but dialed back its 2013 and 2014 forecasts. For unemployment, the outlook is slightly better, with the jobless rate forecasts for 2012 and 2013 adjusted down from January, along with a slight downward adjustment in 2014.

The key question is whether the Fed and its unprecedented actions—low interest rates, newly open communication and quantitative easing—have helped. Many Americans' eyes may glaze over when confronted by the ins and outs of open market transactions, but the Fed's goals—price stability and maximum employment—are important to everyone.

The Fed is unusual in that is mandated to facilitate a strong labor market, not just price stability. And while the Fed's accommodative policies may be helping the job market, many experts agree that its tools are limited.

One chief concern is why the Fed is keeping its interest rates historically low, says O'Keefe.

"If its argument is that it's necessary to bring the rate of unemployment down, then I think the Fed has to answer a second question, which is: What evidence is there that the use of monetary policy in these extraordinary ways has produced a lower level of unemployment or a higher employment rate?"

Greg McBride, senior financial analyst for Bankrate.com, agrees. While explicit forward guidance on interest rates may boost the stock market, he says, "I don't know that companies are out hiring people because they know that interest rates are going to stay low through 2014."



Corrected on : UPDATE: This piece was updated on 4/25 to reflect the Federal Open Market Committee's updated economic projections, as well as Ben Bernanke's 4/25 press conference remarks.