Fed: We're Ready to Aid the Economy and Fight Deflation

Federal Reserve BuildingThe U.S. Federal Reserve is keeping its existing, accommodative monetary policy unchanged, but in its Federal Open Market Committee policy statement issued today it added that it's prepared to take additional action, if necessary, to stimulate the economy and fight deflation.

In its statement -- the last one regularly scheduled before the midterm election on Nov. 2 -- the Fed said: "The FOMC will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and return inflation, over time, to levels consistent with its mandate."

The central bank kept its fed funds target range of 0% to 0.25% unchanged for the 20th straight month, and maintained the same stance or "tone" regarding future interest rate policy, reiterating that it will keep rates "exceptionally low" for an "extended period." The Fed made no new asset purchases.

The decision had one dissenter. Thomas Hoenig, Kansas City Federal Reserve Bank president, voted against the policy for the sixth consecutive meeting.

Out of Its "Comfort Zone"

The Fed added that it sees inflation currently "at levels somewhat below those the Committee judges most consistent, over the long run, with its mandate to promote maximum employment and price stability." U.S. inflation, currently running at about a 1.4% annual rate, is below the Fed's "comfort zone" of 1.5% to 2%.

The central bank added that since it met in August, information received indicated that "the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract, but at a reduced rate in recent months."

The Dow Jones Industrial Average, down about 10 points at 10,748 prior to the Fed's announcement, reverse and rose about 60 points to 10,808 in the initial 20 minutes after the announcement.

More Bond Buying Is Expected in 2010

The Fed's meeting came amid new evidence indicating economists expect the central bank to take additional action to help reheat a U.S. economic recovery that cooled in the second quarter.

In a poll conducted Sept. 16-17, 67% of economists surveyed by Bloomberg News said they anticipate that the Fed will move to boost the economy by the end of 2010 by buying bonds, but they did not necessarily expect it to occur at Tuesday's meeting.

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The FOMC's deliberations also occurred against the usual backdrop of hawkish and dovish voices -- magnified by the size of the Fed's unprecedented quantitative and related monetary interventions, and by the recession's severity, which has resulted in the loss of more than 8 million jobs.

The hawks argue that the Fed has to start withdrawing stimulus now in order to avoid a "runaway freight train" scenario in which the U.S. economy grows too fast and becomes hard to control, with rising inflation. The doves argue that withdrawing stimulus now would be premature and further harm an already tepid and fragile U.S. economic recovery.

Ammunition for the Hawks

The declaration yesterday by the National Bureau of Economic Research (NEBR), the nation's official arbiter of business cycle dates,that the downturn officially ended in June 2009 did little to resolve the conflicting analysis offered by the economic hawks and doves. The official end of the 18-month recession -- the longest since World War II -- is a point the hawks will use to support their monetary-tightening argument.

However, Northwestern University Economist Robert J. Gordon, a member of the NBER's business-cycle dating committee, estimated that the U.S. economy needs annual GDP growth of 2.5% just to prevent the high 9.6% U.S. unemployment rate from rising, The New York Timesreported.

The U.S. economy slowed to an anemic 1.6% growth rate in the second quarter, down from the initially estimated 2.4% and well below the first quarter's 3.7% expansion.
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