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Economic Forecasts

The Fed: Lying Low on Interest Rates

In the face of rising congressional criticism, the Federal Reserve will happily take a pass on the opportunity to raise interest rates.

Now is not the time for officials at the Federal Reserve to make headlines. With the economy giving off mixed signals about the endurance of a recovery and Fed Chairman Ben Bernanke drawing angry comments from Congress, the latest meeting of the policy setting Federal Open Market Committee (FOMC) has come and gone quietly.

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But we still expect the Fed to boost interest rates this year, by a quarter or a half point from the current near-zero federal funds rate. Economic and political forces, however, are likely to delay that rate hike to around November or December, after the congressional elections.

What matters most to the Fed this week is the reappointment of Bernanke, whose four-year term as chairman ends Jan. 31. A few weeks ago, that seemed a certainty. While it’s still likely that the Senate will approve another stint for the former Princeton professor and expert on policy reactions to the Great Depression, criticism of Bernanke’s handling of last year’s financial meltdown and the billions Uncle Sam poured into AIG, Citibank and other Wall Street giants is strong enough to cast a cloud over his future at the Fed. As a result, the White House is mounting a phone call campaign to members of the Senate, making clear its support for the central bank chief.

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Meanwhile, the Federal Reserve itself is trying to ward off proposed legislation requiring congressional reviews of Fed policy and how it is set. A proposed bill from Rep. Ron Paul (R-TX) has widespread bipartisan support and stands a good chance of passage. That worries some observers, who fear that too much oversight of what traditionally has gone on behind closed doors would undermine the Fed’s independence. For example, Richard Fisher, president of the Federal Reserve Bank of Dallas, says that such a move by Congress would open the door to political interference and set the U.S. “on a road that leads directly to economic ruin.”

Modest improvement in the economy -- though with conditions at what the Fed’s latest national survey calls “a very low level” -- provides the Fed with the freedom to delay an interest rate hike. The unemployment rate remains high at 10%, and officials emphasize that with such slack in the economy, inflation pressures are minimal. In the policy statement issued at the end of the FOMC meeting, officials repeated that interest rates will remain near zero “for an extended period.”

Look for the Fed, however, to continue to gradually reduce the liquidity it’s pumped into the financial system over the past year by letting various rescue programs expire. On Feb. 1, four programs -- one aimed at shoring up money market deposits, another to keep credit flowing on short-term IOUs that companies and banks use, plus two more -- will end. And officials restated their goal to stop buying bonds backed by residential mortgages by the end of March.

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