MercoPress. South Atlantic News Agency

Fed admits modest US recovery and will buy long term government debt

Fed chief Ben Bernanke concerned with high unemployment and deflation

The US Federal Reserve announced Tuesday steps to boost economic recovery and will be using proceeds from its investments in mortgage securities to buy longer-term government debt. The Fed also kept interest rates unchanged at between zero and 0.25%.

“The pace of economic recovery is likely to be more modest in the near term than had been anticipated”, admits the Federal Open Market Committee in its report.

Stock markets recovered some of their earlier losses after investors reacted positively but still cautiously to the news. The Dow Jones index, down about 100 points before the Fed announcement, was only 15 points lower shortly afterwards. It closed down 54 to 10,644. US government bond prices also rose.

The report also underlines that to help support the economic recovery in a context of price stability, FOMC “will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities”, and will also continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.

Describing the current situation of the US economy, since the June meeting, FOMC says 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; however, investment in non-residential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level while bank lending has continued to contract”.

Inflation is not seen as a threat in the near future: “measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable” and therefore inflation is likely to be subdued for some time.

On the contrary fears are of a deflationary cycle of falling prices and depressed consumption from taking hold. Consumer prices outside food and energy rose just 0.9% in the 12 months through June, holding for a third straight month at the lowest level seen since January 1966. Hourly compensation for US workers fell at an annual rate of 0.7% in the second quarter, the government said in a report that underscored the lack of an inflationary threat.

Meantime a San Francisco Fed study released found a significant chance the economy would slip back into recession in the next two years, while a monthly survey of economists found that 55% believe the Fed will take more steps to support growth in the next 12 months.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.

Voting against the policy was Thomas M. Hoenig, who judges that the economy is recovering modestly, as projected. Accordingly, he believed that “continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee's ability to adjust policy when needed”.

In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve's holdings of longer-term securities at their current level was required to support a return to the Committee's policy objectives.