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Federal Reserve Maintains the Status Quo

Edmund L. Andrews|The New York Times
Wednesday, 24 Jun 2009 | 10:21 PM ET

Facing an economy that is perking up slightly but still deep in recession, the Federal Reserve left its rescue policies unchanged on Wednesday and said that it would keep interest rates low for “an extended period.”

As expected, the central bank said that it would keep its benchmark overnight interest rate at virtually zero — where it has been since December — and signaled that it would continue buying long-term Treasury bonds and other government-backed securities to keep long-term rates low.

Policy makers did not announce any expansion of efforts to stimulate the economy, even though government forecasters predicted that unemployment would continue to rise from its already high level of 9.4 percent and would not begin to edge down until next year.

In a statement accompanying its decision, the central bank said that the “pace of economic contraction is slowing” and noted that financial markets had generally improved while consumer spending had shown signs of stabilizing.

Policies put in place “will contribute to a gradual resumption of sustainable economic growth in a context of price stability,” the statement said.

But the Fed warned that “economic activity is likely to remain weak for a time,” and repeated its longstanding vow to use “all available tools” to promote a recovery. In its statement, the Fed said that the economy would remain weak and that inflation would remain “subdued for some time.”

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The Fed’s announcement came hours after new data offered more evidence that the downturn was slowing, but hardly over. Orders for durable goods jumped 1.8 percent in May, the second consecutive monthly increase and a much stronger rise than forecasters had been predicting.

By contrast, sales of used homes slumped 0.6 percent last month and the supply of unsold homes remained at high levels. As a result, analysts said, home prices have probably not stopped falling.

The central bank’s caution and the new data highlighted the difficult balancing act that policy makers increasingly face. On the one hand, the economy remains so weak that many policy makers want to keep revving up activity by printing money. On the other, they are under pressure from bond investors, who have signaled growing worry that the Fed’s efforts will eventually drive up inflation.

Long-term interest rates have edged up noticeably since the central bank’s last policy meeting on April 29, partly because investors have become worried about the huge scale of government borrowing.

Since the central bank reduced the overnight federal funds rate to a hair above zero, it has been forced to focus on lowering long-term rates by buying nearly $2 trillion in Treasury bonds, government-guaranteed mortgage-backed securities and bonds issued by government agencies. Buying bonds drives up their prices and reduces their yields, effectively lowering interest rates.

Those purchases did have that effect initially, but long-term Treasury rates have been edging up again, threatening the central bank’s recovery plan.

“The Fed is in a box,” said Frederic S. Mishkin, a former Fed governor who recently returned to his post as a professor of economics at Columbia University’s business school.

“With an economy that still has so much slack in it, having an accommodative monetary policy that will help promote a recovery is what’s needed right now,” Mr. Mishkin said. At the same time, “The Fed does not want to be seen as enabling fiscal irresponsibility, and the markets are very concerned about that.”

Economists estimate that the American economy continued to shrink in the second quarter but much more slowly. Macroeconomic Advisers, a forecasting firm in St. Louis, estimated that the economy shrank at an annualized rate of 1.3 percent from March through June. By contrast, economic output declined 5.7 percent in the first three months of 2009 and 6.3 percent in the last three months of 2008.

Largely because of the depth of the contraction, Fed officials and most forecasters see no signs of inflation ahead. Indeed, the fear has been about deflation, a systematic decline in consumer prices of the kind that plagued Japan through much of the 1990s.

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