WASHINGTON — Federal Reserve officials expect to leave interest rates near zero for years — through at least 2023 — as they try to coax the economy back to full strength after the pandemic-induced recession, based on their September policy statement and economic projections released Wednesday.
The Fed, in a significant update to its official policy statement, also reinforced its August pledge to tolerate slightly higher price gains to offset periods of weak inflation, underscoring that its chairman, Jerome H. Powell, and his colleagues plan to be extraordinarily patient as they try to cushion the economy in the months and years ahead.
The Fed’s moves are in response to two major challenges. The coronavirus pandemic continues to threaten the economy in the near-term, leaving millions out of work, and central bank policy will be key to restoring growth and a strong labor market. A longer-run problem centers on inflation and interest rates, which have been slipping lower, threatening economic stagnation. Officials are hoping that an extended period of very cheap money will fuel demand and lift prices.
In its statement on Wednesday, the policy-setting Federal Open Market Committee said it expected to hold rates steady near zero until the job market reaches what it sees as full employment “and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”
By scrapping their old practice of raising rates in response to a drop in unemployment and an expectation that inflation would rise — and instead requiring inflation to show up in real life as a precondition for higher rates — central bankers are committing themselves clearly to their new policy strategy and to a long period with borrowing costs near zero.
“Effectively we’re saying rates will remain highly accommodative until the economy is far along in its recovery,” Mr. Powell said at a news conference following the meeting, repeatedly calling the messaging “strong” and “powerful.”
The change was important enough to prove contentious. Two officials, Robert S. Kaplan from the Federal Reserve Bank of Dallas and Neel Kashkari from the Minneapolis Fed, voted against Wednesday’s decision. Mr. Kaplan favored retaining greater flexibility about future rate setting — suggesting that he did not want to intertwine interest rates so tightly with real-life inflation outcomes. Maintaining some wiggle room would leave the Fed room to raise rates earlier.
Mr. Kashkari seemed to take the opposite tack. He believes the committee should “indicate that it expects to maintain the current target range until core inflation has reached 2 percent on a sustained basis,” the statement said, arguably a stronger commitment to a period of very-low rates.
Roberto Perli, an economist at Cornerstone Macro who formerly worked at the Fed, said the announcement codified a meaningful change to the Fed’s approach.
“What strikes me is how high a bar they set for raising rates,” Mr. Perli said. “The message is plenty clear: We want to maximize employment and inflation better come up, or no rate hikes here.”
The Fed slashed interest rates to near zero almost exactly six months ago, as the pandemic first swept the United States and markets tiptoed on the brink of disaster. Such low interest rates help to spur economic growth by encouraging home refinancing, business investment and other types of borrowing. While investors and economists already expected borrowing costs to remain at rock-bottom for years, the Fed’s declaration on Wednesday should buttress that outlook.
Mr. Powell tried to hammer that point home, saying that the changes “clarify our strong commitment over a longer time horizon.”
Officials clearly expect that sustained economic support will be needed. During his news conference, Mr. Powell noted that while activity had picked up, the recovery in household spending probably reflected “substantial and timely” fiscal support, and services that involved people gathering together — like entertainment and tourism — would struggle to fully recover until the virus abated.
“Overall activity remains well below its level before the pandemic, and the path ahead remains highly uncertain,” Mr. Powell said.
Cutting the federal funds rate is not the only tool in the Fed’s arsenal — the central bank is also buying huge quantities of mortgage-backed and Treasury securities. The primary goal of those purchases has been to stabilize markets, but bond-buying can help to stimulate the economy by pushing down longer-term interest rates. It can also prod investors to move into riskier assets with higher payoffs, driving them toward corporate bonds and stocks.
Fed officials had been mulling when and how to update their asset purchase program, and said Wednesday that they would maintain purchases “at least” at their current pace to “sustain smooth market functioning and help foster accommodative financial conditions.”
Mr. Powell said that the purchases were helping to keep credit flowing in the economy.
“There are various ways and margins that we can adjust our tools going forward, and we’ll continue to monitor developments,” he said.
Even so, the Fed’s powers are limited and the central bank head once again noted that more fiscal support — the kind of direct spending that only Congress can authorize — would be needed to help the economy continue its recovery.
“My sense is that more fiscal support is likely to be needed,” he said.
Millions of people remain out of work and it is unclear how quickly — or even if — all of those workers will find re-employment.
The median Fed official now expects the unemployment rate to average 7.6 percent over the final three months of the year, which is lower than officials had previously expected but still sharply higher than the 3.5 percent rate that prevailed heading into the downturn. Those projections were included in the Fed’s updated Summary of Economic Projections, a set of estimates for how the economy and interest rates will develop in coming years. It was the so-called S.E.P. that showed interest rates on hold through 2023, based on the median forecast.
“The labor market has been recovering, but it’s a long way, a long way, from maximum employment,” Mr. Powell said, adding that the recovery will move most quickly through areas that were not directly affected by the virus. Parts of the economy facing a direct hit — like airlines, sports stadiums and restaurants — “are going to be challenging for some time.”
“It’s millions of people,” he said, adding that it is the Fed’s job “not to forget those people.”
As part of that effort, Mr. Powell in August announced that the Fed was shifting its policy strategy, and no longer planned to lift interest rates simply because the unemployment rate had dropped below levels it saw as sustainable. That came alongside the shift to average inflation targeting, which will allow prices to run slightly higher than 2 percent at times.
The September statement backed up that move.
“The committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent,” the Fed said Wednesday. Previously, it had pledged to aim for 2 percent inflation on a “symmetric” basis, meaning that the Fed was equally unsatisfied if inflation ran above or below the target.
“If we do lift off, we will keep policy accommodative until we have a moderate overshoot of inflation for some time,” Mr. Powell said.
Inflation in the United States has slipped lower over recent decades along with sustainable growth and interest rates. Similar trends have played out in Europe and especially Japan, where inflation has slipped stubbornly lower despite aggressive central bank interventions in recent years.
Nudging price gains slightly higher would buy Fed officials more room to stimulate the economy when needed, since rates incorporate inflation. A little inflation is also thought to grease the wheels of the economy, giving employers room to pass along price increases and raise wages.
“To the extent that inflation gets lower and lower and lower, interest rates get lower and lower,” Mr. Powell said. “This isn’t some idle academic theory, this is what’s happening all over the world — if you look at many, many large jurisdictions around the world, you are seeing that phenomenon.”
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