Yes, the Feds kept their benchmark overnight lending rate at between zero and 0.25 percent, where it has been since December. But as always, there is much more to the story. A few things officials said and their potential impact on the economy:
The Fed completed its $300 billion program of purchasing Treasuries last month. By purchasing Treasuries, the Fed was monetizing the debt and, figuratively speaking, printing money. By putting this excess liquidity into the economy, inflation becomes more of a threat. In addition, the Feds are actually in competition with investors who purchase treasuries. A potential side effect is that the government eventually will not be able to find buyers to finance our record deficits and rates will have to go higher to attract investors, including creditor nations such as China.
Today's statement said the central bank will purchase a total of $1.25 trillion of agency mortgage- backed securities and "about $175 billion of agency debt" through the first quarter of next year. These purchases make mortgage money available and provide artificially low mortgage rates available to home buyers. By shoring up the housing market, this probably a "necessary evil" to keep the housing market's nose above water. Again, the risk is that the trillions of dollars being pumped into the economy could spark inflation once the economy truly begins to heat up.
The Fed said "household spending appears to be expanding, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit." Indeed, the sure road to recovery depends upon the consumer, and to be more precise, jobs. A little trivia . . . The Feds have never raised interest rates while unemployment is rising. As soon as you see unemployment data improve, interest rates will likely rise in an effort to keep inflation at bay.
Policy makers added that companies "continue to make progress in bringing inventory stocks into better alignment with sales." This is yet another reference to the unemployment situation. Because there is plenty of excess capacity in the system, there is a lot of "slack" in the economy that needs to be taken up before companies will need to begin hiring again.
According to Bloomberg, record-low interest rates and Fed purchases of Treasuries and mortgage debt, combined with the Obama administration's $787 billion fiscal stimulus, helped boost gross domestic product 3.5 percent from July to September. Without the auto industry, which benefited from the government's "cash for clunkers" program, growth would have been 1.9 percent. "We are in recovery, the outlook has improved, but they aren't ready to sound the all clear," Julia Coronado, senior U.S. economist at BNP Paribas SA in New York, said before the announcement. "You still have a fractured banking sector and credit is still contracting."
Just a commentary on the oft cited statement that credit is tight. Yes, credit has tightened due to financial institutions wise policies to shy away from weak borrowers, but you can be sure that banks are thrilled to lend to strong borrowers. However, to a large extent, businesses and consumers are hunkering down and don't want to borrow until there are sure signs that the economy is getting better.
Bottom line; the Feds are in a precarious position. They feel that they need to continue to shore-up the economy until they are sure that the recovery has taken hold. On the other hand, there is a real risk of inflation if they aren't able to drain the trillions of dollars of liquidity that they pumped into the system. The second half of 2010 should tell the story, and should be a very interesting chapter in this, the worst recession since the Great Depression.
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