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Fed Unemployment Projection: Jobless Rate Will Stay High For Next 2 Years

JEANNINE AVERSA   02/17/10 05:09 PM ET   AP

Fed Unemployment Projection

WASHINGTON — With the economy healing, Federal Reserve officials debated last month when to reel in the extraordinary stimulus aid they injected into the economy. Some officials wanted to start selling assets on the Fed's books "in the near future," documents released Wednesday show.

Selling assets would sop up some of the stimulus money and shrink the Fed's $2.2 trillion balance sheet. But many members expressed concern that such transactions could drive up interest rates and hurt the economic recovery.

Last week, Fed Chairman Ben Bernanke said he didn't expect any asset sales soon. The documents on the Fed's closed-door meeting last month pointed to divergent thoughts about the timing and tools to reverse course and start tightening credit.

"The upshot is that as it stands now, nothing is set in stone," said Paul Ashworth, economist at Capital Economics.

The Fed also released a forecast Wednesday predicting unemployment will stay high over the next two years because recession-scarred Americans are likely to stay cautious.

At the Jan. 26-27 meeting, the Fed left rates at a record low near zero to help nurture the recovery and drive down unemployment. And it pledged to hold rates at "exceptionally low" levels for an "extended period."

One Fed official, Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, objected to maintaining that pledge. He feared it would increase inflationary pressures, the documents show. Instead, Hoenig wanted to change the language to say rates would stay low for "some time."

Hoenig said he thought such a change would give the Fed more flexibility to start raising rates, the documents said. Hoenig also thought a move toward "modestly higher" interest rates should happen soon.

Bernanke, in remarks last week, suggested the Fed is still months away from raising rates and draining money out of the financial system. The recovery is still fragile and unemployment, now at 9.7 percent, is high.

In its economic forecast, Fed policymakers said it will take "some time" for the economy and the jobs market to get back to normal. They did not spell out how long that would be. Previously, they suggested it could take five or six years for economic conditions to return to full health.

A "sizable minority," though, said they thought it could take more than five or six years for the economy and the job market to return to normal.

The Fed said the unemployment rate this year could hover between 9.5 percent and 9.7 percent and between 8.2 percent and 8.5 percent next year. By 2012, the rate will range between 6.6 percent and 7.5 percent, it predicted.

Those forecasts are little changed from projections the Fed released in late November. But they suggest unemployment will remain elevated heading into this year's congressional elections and the presidential election in 2012. A more normal unemployment rate would be between 5.5 percent and 6 percent.

Fed policymakers "expect that the pace of the economic recovery will be restrained by household and business uncertainty, only gradual improvement in labor market conditions and a slow easing of credit conditions in the banking sector," according to the forecast.

Against that backdrop, the Fed expects the economy will grow between 2.8 percent and 3.5 percent this year. Growth will pick up to between 3.4 percent and 4.5 percent next year and log similar growth in 2012. The economy would need to grow by at least 5 percent a year to make a dent in the unemployment rate, analysts say.

Further insights into the Fed's view of the economy and its strategy for reeling in stimulus money will likely come at a House Financial Services Committee hearing next Wednesday. That's when Bernanke will deliver the Fed's twice-a-year economic report to Congress.

As Fed policymakers debated ways to bring policy closer to normal, most thought that a future program of "gradual" asset sales could be helpful in shrinking the Fed's balance sheet.Among those the Fed's assets are mortgage securities it has bought from Fannie Mae and Freddie Mac.

The Fed is scheduled to end $1.25 trillion worth of such purchases at the end of March. The purchases are aimed at lowering mortgage rates and bolstering the housing market. The Fed has held the door open to extending the program if the economy weakened. Some analysts fear that once the program ends, mortgage rates could rise, hurting the recovery in housing and the overall economy.

Last week, Bernanke said the central bank will likely start to tighten credit by boosting the rate it pays banks on money they leave at the central bank. Doing so would raise rates tied to commercial banks' prime rate and affect many consumer loans.

Fed officials said that bumping up the interest on bank reserves would be a key element of their exit strategy, according to Wednesday's documents. Officials offered a range of strategies on how this and other tools could be used.

Meanwhile, Fed staff suggested a bump-up in the rate banks pay the Fed for emergency loans. An increase in that rate – now 0.50 percent – wouldn't affect interest rates charged to consumer and business borrowers.

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Filed by Ryan McCarthy  |