TOPICS > Economy

Fed Holds Key Interest Rate at Record Low

BY Lea Winerman  August 12, 2009 at 2:22 PM EDT

Ben Bernanke; Getty Images

The announcement, the resultof a two-day policymaking meeting, signals how the Fed intends to respond to signs that an economic recovery may be beginning, but that the road to recovery will likely remain bumpy.

The central bank’s challenge is to balance the need to keep low interest rates and programs in place to stimulate the still-sluggish economy, while assuaging fears that the low rates could lead to inflation once economic recovery begins.

The Fed slashed interest rates to a range of between zero and 0.25 percent in December and has pumped hundreds of billions of dollars into the economy to stimulate economic activity in the worst recession in decades.

The central bankers also debated whether to extend some of the economic-stimulus programs put in place over the past year. Most immediately, they decided to extend a program that was scheduled to end in September to buy $300 billion in long-term Treasury bonds. However, they said that the program — intended to lower longer-term interest rates — would now end in October.

“To promote a smooth transition in markets as these purchases of Treasury securities are completed, the committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October,” the Fed said in a statement after the meeting.

U.S. Treasury prices tumbled after the statement in apparent disappointment that the Fed did not increase the amount of debt that it plans to buy.

Recent economic data have suggested some signs of recovery. The unemployment rate dipped slightly from 9.5 percent to 9.4 percent in July, and the Labor department said Tuesday that productivity jumped in the second quarter of 2009 to 6.3 percent, much higher than the annual average of 2.6 percent over the past decade.

But each of those indicators comes with a caveat. The unemployment rate dipped partly because more than 400,000 people dropped out of the workforce entirely and are no longer looking for jobs. And a higher productivity rate was due mainly to companies cutting hours, so that labor costs per unit fell.

“It’s going to be a recovery only a statistician could love,” Wells Fargo senior economist Mark Vitner told the Washington Post, saying that the signs of economic recovery were unlikely to translate into more jobs and higher wages any time soon.

While there may be some signs of a recovery, the Fed is tasked with the tricky task of keeping the economy from slipping again.

“This has been such a severe economic decline that we could easily tip into a double-dip recession or have a slow recovery,” Bruce McCain, chief investment strategist of Key Private Bank in Cleveland, told the Washington Post. “But the longer you leave the programs in place, the more inflation risk there is. That makes it a very tough time to figure out what to do to negotiate between those two rocky shores.”