Analysis: The Fed's Rate Decision and Exit Strategy

Last Updated Sep 23, 2009 3:41 PM EDT

Editor's Note: Economist Mark Thoma is guest-blogging for The Macro View this week.
After its rate setting meeting today, the Fed announced that it "will maintain the target range for the federal funds rate at 0 to 1/4 percent," and that it "continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period" (here's the full press release). Very few analysts thought the Fed should raise the rate--calls for higher rates came from a few inflation hawks but that's about it, and nobody I know of expected the Fed to change its interest rate policy. So no surprises here.

Of more interest are the Fed's characterization of economic conditions, as well as its plans for the special facilities and other non-standard monetary policy options it has put in place to deal with the crisis. The Fed seemed more positive about the economy than it has been in the past, and further indication of this came with its announcement that it will wind down the purchase of mortgage backed securities and stop doing so altogether early next year. The Fed also reiterated its plans to end the purchase of Treasury bonds.

But while the Fed sees positive signs and is beginning to execute an exit strategy, the fact that it is keeping interest rates on hold indicates that it expects a slow, drawn-out recovery. I also expect a slow recovery, particularly for the labor market, so I'm glad to see that the Fed is being cautious and wants to avoid the mistake of raising rates too soon. It's a delicate tradeoff--if the Fed waits too long to raise rates, it could stoke inflation, but if it tightens too soon, it could choke off the recovery. My view is that if the Fed is going to make a mistake, it ought to err on the side of the recovery and stoking employment, and it looks to me like the Fed has similar sentiments.