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Fed official: Use thresholds to raise interest rates

by David Smith | December 4, 2012 at 12:42 a.m.

— The Federal Reserve should consider changing its summer 2015 timetable to raise interest rates and instead raise rates if unemployment falls below 6.5 percent and inflation remains under 2.5 percent, the president of the Federal Reserve Bank of St. Louis said Monday.

One reason the change would be a wise move, James Bullard said, is that it avoids the implication the economy may not improve for almost three years.

The Fed does not intend to send such a signal, Bullard told a luncheon crowd of more than 900 at the 147th annual meeting of the Little Rock Regional Chamber of Commerce at the Statehouse Convention Center.

The Fed has kept the federal funds rate at about 0.25 percent since December 2008 and has promised to keep it there until the middle of 2015.

“A possible alternative would be to get rid of the date and replace it with thresholds, which are values of unemployment and inflation,” Bullard said.

The national unemployment rate in October was 7.9 percent. The Labor Department will release the November unemployment rate on Friday. The consumer price index in September was an annualized 2.2 percent, in line with the Fed’s inflation target.

The current policy of dating the time of a change in the Fed interest rate as mid-2015 is “not giving the public much of a guidance about what [the Federal Reserve] is looking for to return to some sort of normal policy stand,” Michael Pakko, chief economist at the Institute for Economic Advancement at the University of Arkansas at Little Rock, said in a telephone interview.

“I think some sort of threshold would be an improvement,” Pakko said. “When they give a timeline for the removal of a policy it almost seems like a forecast of how long weak economic activities are going to persist.”

Bullard has support among other Fed bank presidents for the change.

Charles Evans, president of the Federal Reserve Bank of Chicago, also said recently that the central bank should keep interest rates near zero until unemployment falls to 6.5 percent or lower as long as inflation is under 2.5 percent.

Changes in the federal funds rate are the Fed’s primary lever for influencing the economy. The benchmark rate directly influences other short-term interest rates, such as the prime rate and credit card rates.

However, the Fed’s bigger influence on the economy comes from its monetary policy’s effects on long-term borrowing costs, such as rates on mortgages and corporate debt.Those interest rates affect the prices of stocks, bonds, real estate and other assets.

Bullard didn’t address the “fiscal cliff” at the luncheon. But an audience member asked how dire the consequences would be if Congress doesn’t respond to the fiscal cliff, which refers to a cluster of government policies that are scheduled to take effect in January if changes aren’t made. Without adjustments, the fiscal cliff could cut more than $500 billion out of the country’s economy next year.

The Congressional Budget Office says the country’s gross domestic product would suffer significantly and it would take awhile for the economy to adjust if the fiscal cliff isn’t avoided, Bullard said.

And the Fed couldn’t adjust quickly enough to help much, Bullard said.

“I want to stress that that kind of shock would be too large for the U.S. monetary policy makers to react to in a way that would offset the effects of the fiscal cliff,” Bullard said.

Information for this article was contributed by Steve Matthews of Bloomberg News.

Business, Pages 23 on 12/04/2012

Print Headline: Fed official: Use thresholds to raise interest rates

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