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Fed stands pat despite GDP slump

News Analysis

(MoneyWatch) The Federal Reserve announced today that monetary policy will remain on its present course of extraordinarily low interest rates and bond purchases -- also known as quantitative easing -- of $85 billion per month.

How long will the low interest rate and bond purchase policies continue? There was no change in the Fed's previous announcement that it will continue to target a near-zero interest rate until unemployment falls below 6.5 percent or inflation expectations drift more than half a percent above the Fed's 2 percent target.

The conditions for ending the central bank's monthly bond purchases remain vague. Many analysts thought the Fed might be more specific today about when it plans to end the bond purchases. But for now all we know is that the interest rates will remain low "for a considerable time after the asset purchase program ends and the economic recovery strengthens;" that is, bond purchases will end before the interest rate is increased. But the precise conditions that will lead to the end of the bond buying program have been left unspecified. The Fed does not like uncertainty about its policies, so the likely reason for the lack of firm guidance on this point is disagreement among the board members about the exit conditions for this program.

However, the latest GDP report showing that the economy shrank an annualized 1 percent in the final three months of 2012 indicates that we have not yet reached the acceleration in the recovery the Fed wants to see before it ends its bond purchases.

There are reasons to discount the falloff in growth. It is a preliminary figure that will be revised, perhaps substantially. The number is also driven primarily by two volatile components of the GDP report, defense spending and inventories, and events such as hurricane Sandy may have distorted the Fed's seasonal adjustment procedure.

But even with these qualifications, the Fed is looking for clear signs that the recovery is strengthening before it ends its bond purchases, and those signs are missing from this report. If anything, today's GDP report ought to lead to more pessimism rather than more optimism that the recovery will strengthen soon, and that points to an extension in the expected time until the Fed begins reversing its policies.

Nevertheless, it's likely that many policymakers will look through these numbers as an aberration, particularly since they are inconsistent with other growth indicators such as housing, employment and consumer spending, all of which have been relatively strong in recent months.

So despite today's lackluster economic update, the Fed remains in a holding pattern due to uncertainties about the GDP numbers and conflicting indicators of where the economy is headed. Until the data are clear one way or the other -- a strengthening recovery or a continuation and confirmation of the low GDP and employment growth numbers we saw today -- that is unlikely to change.

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