January 25, 2012
More of the same: Interest rates near zero for at least three
more years in the United States
Policy Rates of Central Banks
Japan Discount Rate
Fed Funds Target Rate
12
12
10
10
8
8
6
6
4
4
2
2
0
0
85
90
95
00
05
Sources: Federal Reserve Board, Bank of Japan /Haver Analytics
10
Appropriate Timing of Policy Firming
(number of FOMC participants)
8
6
5
4
4
The policy rate of the U.S. Federal Reserve has been sitting in the
target range of 0% - 0.25% for three years now. In its statement, the
Federal Reserve mentions that economic conditions "are likely to
warrant exceptionally low levels for the federal funds rate at least
through late 2014." We interpret this as a major shift, since the
Federal Reserve had been saying "mid-2013" since August 2011.
Accordingly, the United States will go through a period of at least six
years with a policy rate near zero, which is looking more and more like
a "lost decade". This is especially true for savers, not just in the United
States but also in Canada; they are the big losers in this environment
of extremely low interest rates.
The clear signal ("at least through late 2014") being sent by the
Federal Reserve stems from the paltry economic outlook, which is not
robust enough to achieve the two primary objectives of minimizing
unemployment and promoting price stability. New projections indicate
that unemployment will decline slowly over the next three years.
Meanwhile, inflation will remain well below 2% – the new “official”
longer run target. Moreover, strains in global financial markets pose
significant risks to the economic outlook.
In this context, continuing the program to extend the average maturity
of the Federal Reserve's balance sheet (Operation Twist) was not
2
enough as the year 2012 got underway. It was necessary to extend
the period of near-zero interest rates for at least three more years.
0
This increased openness and clarity is one of two tools being used to
stimulate the U.S. economy at this point. The goal is to shape further
2012
2013
2014
2015
2016
bond market expectations (which initially worked amid a decline in
Source: Federal Reserve
yields Wednesday afternoon) and to encourage risk-taking by
households and businesses. The latter have been somewhat reluctant to spend and to hire, despite the very-low-interest-rate
environment (liquidity trap). The other tool available is to expand the Federal Reserve's balance sheet by purchasing securities.
Indeed, another round of quantitative easing (QE3) is still an option on the table, according to Bernanke's comments during the
press conference. The problem is that Bernanke's past efforts have often been for a set time period, and came to an end even
though his dual mandate had not been fulfilled. This was the case with QE2 ($600 billion worth of bond purchases between
November 2010 and June 2011). The subdued unemployment and inflation forecasts actually pave the way for QE3. We predict
that QE3 will see the light of day by mid-2012.
3
3
2
Finally, Bernanke told market participants to pay more attention to the particularly gloomy statement rather than to the eagerly
awaited novelty: the publication of forecasts for the target federal funds rate by the 17 FOMC members (these forecasts are
more optimistic than the statement). Of course, the 17 FOMC members are not all on the same page, which created some
confusion at first glance. For example, most of them (11 of the 17) feel that the first increase in the target federal funds rate will
occur by 2014. One of these is certainly Jeffrey Lacker, who fears a surge in inflation. That said, the main message to remember
from the Federal Reserve is that the US is not likely to experience a strong phase of recovery in the next three years. That was
enough for the central bank to be more transparent than ever before.
Sébastien Lavoie, Assistant Chief Economist
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