Fed pledges to keep policy rates “exceptionally low”

Here is an interesting approach to interest-rate setting by the US Central Bank - the Federal Reserve. The Fed has pledged to maintain ultra-low interest rates for the time being in a bid to support and sustain a recovery in domestic demand and output and reduce the risk of a double-dip recession later on this year.

“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

Expectations play a key role in shaping the nature and speed of an economic recovery. If businesses believe that nominal interest rates will stay low (and that they can benefit from an unfreezing of business finance) the chances of a stronger pick up in stocks and then capital investment are higher. Consumers too (and home-owners in particular) will breathe a sigh of relief that monetary policy will not be tightened too early before a recovery has a better foothold.

Any the Fed sending this signal about interest rates has caused the US dollar to depreciate in the currency markets (low interest rates cause hot money flows to look elsewhere for higher returns) - a lower dollar is a boost to the export industries in the US and a cause of a sharp jump in the Dow Jones index.

The absence of demand-pull and cost-push inflationary pressures helps the Fed to push the view that rates will stay low. And their dual mandate of price stability and maintaining growth also gives them more leeway to maintain an expansionary stance.