bank rates

Interest Rates Now Tied To Employment

rate arrow crashing down.6.5%.

That’s the new number to commit to memory.

The Federal Reserve has abandoned a date-specific target for when it plans to boost interest rates. Instead, the Fed now says it will hold rates near zero until unemployment dips to 6.5%, presuming inflation remains in check.

We’re a long way from unemployment reaching that level, a mark unhit since October 2008, just as the economy was collapsing. Unemployment was at 7.7% in November, according to the Bureau of Labor Statistics.

This change announced today by the Fed’s rate-setting committee doesn’t necessarily signal a change in when the Federal Open Markets Committee thinks it will increase rates. Its own projections suggest unemployment most likely will remain above 6.5% until 2015.

As you’ll recall, the Fed in September projected it would increase rates in mid-2015.

I see this more as a change in transparency. The Fed now is explicitly telling us what economic conditions would prompt it to raise the federal funds rate, the interest rate the Federal Reserve charges commercial banks to borrow money.

This is how the Fed influences how much savers earn on their deposits. If banks get essentially free money from the government, there’s no need to pay consumers for their deposits.

From today’s announcement:

In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. The Committee views these thresholds as consistent with its earlier date-based guidance. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. (Emphasis added.)

Since December 2008, the Federal Open Markets Committee has held the federal funds rate at 0% to 0.25%.

The average 5-year CD paid 3.25% APY as that month opened. It pays a record-low 0.92% APY today.

Update: I should also point out, the Fed signaled this shift before. At its meeting in September, committee members discussed at length shifting away from a date-specific target for raising rates in favor of a data-specific target.

But what Fed Chairman Ben Bernanke made clear today in a post-meeting news conference is that this was neither a shift in policy nor an absolute mandate.

“There’s no real change in policy,” Bernanke said. “What it is, instead, is an attempt to clarify the relationship between policy and economic conditions.”

Rates, he said, will increase “sometime after” unemployment goes below 6.5% and should rise “relatively slowly.”

At least one Fed watcher said the move today is good news for the economy.

“This is as aggressive as Fed easing has ever been, and long-term Treasury yields have responded by rising,” Sherry Cooper, chief economist for BMO Financial Group, said in a statement. “Some might suggest that this reflects inflation fear, but also likely, it reflects the market’s view that the Fed means business and the economy will recover more rapidly than previously thought.”

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