The Fed Stays the Course

Officials see the economy improving but fret about ongoing cuts in spending and hiring by businesses.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

September 23, 2009

Don’t expect the Federal Reserve to hike interest rates till fall 2010 or so. More upbeat on the economy than in August, Fed officials nevertheless continue to hold off on any signals of coming interest rate hikes.

The Fed’s policy arm, the Federal Open Market Committee, wrapped up a two-day meeting Wednesday leaving the benchmark federal funds rate near zero. In a statement, the FOMC members said the rate would remain “exceptionally low…for an extended period of time.”

While optimistic, officials noted that businesses continue to cut investments and payrolls. Diane Swonk, chief economist with Mesirow Financial, says, “It doesn’t feel like a recovery to Main Street. That’s one reason the Fed isn’t talking about an exit strategy.”

Critics of the Fed’s reticence warn that it takes time for credit tightening to work, and they have been urging the monetary gurus to send a signal that rates soon will be raised. But the FOMC statement that “inflation will remain subdued for some time” makes it clear that the Fed policymakers disagree about the need for haste. In fact, some officials are raising concerns about deflation because of high unemployment, stagnant wages and falling home prices.

The economy appears to be on track to post an increase of 3% or more in gross domestic product this quarter. Stepped-up auto production and increases in housing construction bode well for fourth quarter growth, too.

But GDP aside, employers continue to lay off more workers than they’re hiring. And the unemployment rate, at 9.7% in August, is heading toward 10% and likely will remain above 9% at the end of 2010.

Those conditions were cited in remarks earlier this month by Federal Reserve Chairman Ben Bernanke, who said, “Even though from a technical perspective the recession is very likely over at this point, it is still going to feel like a very weak economy for some time.”

Though it left rates unchanged, the FOMC did mention its plans to slow its buying of securities to aid the mortgage market, small businesses and commercial real estate. The Fed intends to reduce its purchases of debt pegged to residential mortgages with an eye toward ending that program by March 31, 2010.

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