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Federal Reserve Debates Next Steps After Shifting Approach to Rate-Setting


WASHINGTON — Federal Reserve officials are contemplating their next steps after announcing a new approach to interest rate-setting last month, one that could lay the groundwork for longer periods of low unemployment and rock-bottom borrowing costs.

But it may be too soon for Fed officials to make big changes to their policy-setting at their September meeting, which concludes on Wednesday, because they might need more time to coalesce around their next steps, economists said.

The Fed slashed interest rates to near zero in March, and it is broadly expected to leave them there for years. Officials are now debating whether to concretely communicate their future plans for rates — often called forward guidance — by promising that they will not lift them until inflation, employment or both cross some preset threshold.

They are also discussing when and how to update their bond-buying program. Since March, the central bank has been purchasing large amounts of Treasury and mortgage-backed securities to keep markets functioning smoothly, but officials have signaled that they will eventually shift that program to focus instead on stimulating economic growth.

Either change could add a little more oomph to the central bank’s policies, potentially helping to fuel the recovery from the coronavirus-induced economic crisis. While some analysts expect changes imminently, most anticipate that the 17 Fed officials, 12 of whom vote on the rate-setting Federal Open Market Committee, will take longer to make those major steps. The Fed will provide a post-meeting statement and update its economic projections on Wednesday.

“It feels like there’s going to be a forward lean from them — there’s a refinement coming,” said Julia Coronado, a former Fed economist and founder of MacroPolicy Perspectives. Still, she does not expect either threshold-based forward guidance or a big tweak to the bond-buying program just yet. “This is a big and diverse committee, these are complicated issues, and it is uncharted territory.”

The central bank’s Summary of Economic Projections, a document in which officials anonymously forecast where interest rates, inflation and unemployment will be in coming years, will get a refresh at this meeting.

The so-called S.E.P. will extend through 2023 for the first time. Economists said they expected the Fed to indicate that interest rates would remain on hold throughout that period, reinforcing its plans to be very patient in removing the cushion it is now providing the economy. Low interest rates spur growth by making credit cheaper — encouraging homeowners to refinance, which frees up spending money, and inspiring businesses to invest.

Fed officials will also almost certainly revise down their unemployment rate projections in the document, because the jobless rate declined from 14.7 percent in April to 8.4 percent in August, a faster drop than the central bank had expected. When the Fed released its last set of projections in June, officials expected unemployment to average 9.3 percent in the last three months of 2020.

But officials’ inflation forecasts are more of a wild card.

Jerome H. Powell, the Fed chair, announced in August that the central bank was shifting its monetary policy approach, and no longer planned to lift interest rates simply because the unemployment rate had dropped below levels it saw as sustainable. Officials will also adopt an average inflation target, aiming for 2 percent over time rather than as an absolute goal — implying that they will sometimes allow price increases to run slightly faster.

The point is to keep inflation from dropping ever lower, which would leave the central bank less room to aid the economy in the future by cutting rates, which include price gains.

Despite that shift, few economists expected officials to pencil in an inflation rate above 2 percent in 2023, in part because the outlook for price increases is tepid.

“We also expect that most participants will be reluctant to show conditions that could be interpreted as consistent with liftoff, even at a 2023 horizon,” David Mericle at Goldman Sachs wrote in a research note previewing the meeting.

The Fed releases a statement explaining its policies after its meetings, and that document will probably be updated to reflect the new approach. It could change the language that promises to strive for a “symmetric” 2 percent inflation target — meaning one that is equally unsatisfied if inflation runs above or below the target — to phrasing that pledges to aim for 2 percent over time.

The statement might also upgrade its description of the economy, which has performed better than expected as virus cases moderate somewhat, joblessness declines and consumer spending measures more or less hold up, despite the lapse in a $600 weekly unemployment insurance supplement that ended in late July.

Michael Feroli, chief U.S. economist at JPMorgan Chase, predicted in a note that the Fed would “take note of the pickup in economic activity and employment without celebrating it.”

It is unclear whether the Fed will provide guidance on the future path of interest rates at this meeting. Officials are considering whether they should tie their next steps on interest rates to unemployment and inflation thresholds, which the central bank did after the 2008 financial crisis.

Some regional Fed presidents have indicated that they would favor waiting and making such changes once they had more information about the economy, especially because investors already thoroughly understand that rates will be low for a long time.

“I don’t feel like there’s a burning pressure that we need to change our forward guidance today to change market expectations,” Neel Kashkari, the president of the Federal Reserve Bank of Minneapolis, said on a Bloomberg podcast in late August. That sentiment has been echoed by several of his colleagues, including the Atlanta Fed’s Raphael Bostic and the Boston Fed’s Eric Rosengren.

Fed officials might also prefer to wait for more information before they provide an update to their plans for bond buying. The Fed is planning to eventually shift its asset purchases to more explicitly focus them on stimulating the economy, which could include buying bonds with longer time frames.

But some economists did think that the central bank could make major moves at this meeting, if only to back up its recent strategy shift.

Seth Carpenter, a former Fed economist now at the bank UBS, said he expected the central bank to tie its interest rate outlook to its forecast for inflation. He thinks the Fed needs to do something to follow through on the unveiling of its strategy shift.

“They really are in a bind,” Mr. Carpenter said. “Not doing anything, and not having hit your goals in the past, seems like a recipe for having your goals disbelieved.”

In any case, Mr. Powell will answer questions from the news media after the meeting at 2:30 p.m. on Wednesday. He could echo his colleagues — and repeat his own occasional admonition — in urging Congress and the White House to continue supporting the economy.

Key supports for the economy, including the $600-a-week expansion to unemployment insurance, expired in late July. While President Trump has enacted partial stopgap measures, those will run out, and they do not provide the holistic help that a congressional package might. And talks over legislation have stalled for more than a month, with deep divisions between Republicans and Democrats.

“Partisan politics threatens to endanger additional fiscal relief,” Charles Evans, the president of the Federal Reserve Bank of Chicago, said in a speech this month. “A lack of action or an inadequate one presents a very significant downside risk to the economy today.”



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