Fed Tying Low Interest Rates To Job Creation

Federal Reserve policymakers issued a statement Wednesday saying they will keep interest rates low until the unemployment rate falls to 6.5 percent. Identifying a specific target for unemployment is a big change for the Fed and is part of its effort to become more transparent.

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In an historic move today, Federal Reserve policymakers announced a bold new plan to boost the economy. They added a new round of stimulus. And for the first time, they're establishing a target for the unemployment rate, vowing to keep interest rates low until the target is hit. NPR's John Ydstie reports.

JOHN YDSTIE, BYLINE: Federal Reserve governors have been thinking about setting a target unemployment rate for some time. Their hope is that doing so will help them communicate better with the markets. Specifically, they would describe the economic conditions under which they would start moving interest rates up again. Today, they took the plunge.

In the statement released following their meeting, Fed officials said they anticipate that their benchmark short-term interest rate will remain near zero until the unemployment rate comes down to 6.5 percent. In his post-meeting news conference, Fed chairman Ben Bernanke explained the rationale.

BEN BERNANKE: We think it's a better form of communication. We think it's - by using the thresholds, which ties rates to economic conditions, we're more transparent about what's going to determine our policy in the future.

YDSTIE: Bernanke made clear that the 6.5 percent target is not the level of unemployment the Fed wants for the economy. It's the threshold where policymakers would begin to move interest rates off their current rock-bottom level. But there is a caveat. If inflation is projected to rise to 2.5 percent in the next year, the Fed might start raising interest rates to rein it in, even if the unemployment rate is above the target level. Right now, the unemployment rate is 7.7 percent and the inflation rate is stable at around 2 percent.

Former Fed vice chairman Alan Blinder, now a professor at Princeton, says the unemployment target is a good idea. He says the old calendar formula the Fed used, telling the public most recently that they expected to hold rates extremely low until mid-2015, was not very useful.

ALAN BLINDER: Because, first of all, there is no significance to the calendar, it's really the economy. And those numbers were kind of guesses by the Fed as to when the economy would get in the kind of configuration where it would think about raising interest rates. So in that case, well, why not just say what the economy would have to look like in order to do that?

YDSTIE: Another former Fed governor, Randall Kroszner, now at the University of Chicago's Booth School of Business, says this is a milestone in Chairman Bernanke's effort to help the Fed communicate more effectively.

RANDALL KROSZNER: I sometimes say it's open mouth operations, rather than open market operations that are really the key here. And I think that's precisely the reason the Fed is doing this because it hopes that this can speed the reduction in the unemployment rate.

YDSTIE: In addition to amping up its communications strategy, Fed policymakers also ramped up their stimulus for the economy today. They said they'd continue to buy $40 billion worth of mortgage-backed securities a month, and they also said they'd purchase $45 billion monthly in long-term Treasury bonds. Blinder said it reflects the Fed's concern about the sluggish economy. But Kroszner thinks the added stimulus is unlikely to be very effective.

Bernanke also got lots of questions about the fiscal cliff, a term he coined. He declined to answer questions about the specific tax hikes or spending cuts the Congress and White House should enact. But he did give this advice.

BERNANKE: That, at a minimum, Congress should try to do no harm; that they should try to avoid policies that significantly slow or derail the recovery at this point. So I think that's the critical thing along with the long-term objective of achieving a sustainable fiscal path.

YDSTIE: In other words, get the long-term budget deficits under control, but don't derail the fragile economic recovery in the process. In fact, Bernanke added that if there were a way to get some added stimulus in the economy in the short-term, while solving the long term budget problem, that could be helpful. John Ydstie, NPR News, Washington.

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