WASHINGTON — The Federal Reserve, recognizing that its once-brighter hopes had ended in disappointment, issued a grim new assessment of the American economy that essentially acknowledged the recovery is likely to remain weak and unemployment high for the next two years.
With Congress and President Barack Obama seemingly gridlocked over major new economic initiatives, the central bank had become the last player standing in terms of financial policy-making. But a divided Fed policy committee did not go beyond saying it was prepared to hold its benchmark short-term interest rate at near zero through at least mid-2013.
That rate, which potentially influences mortgages and consumer loan rates, has been at rock bottom since December 2008, so the extension is not expected to have a significant effect — not with most businesses and consumers seeing little reason to borrow money in the fragile economy.
Stocks fell initially but then rallied. The Dow index closed up nearly 430 points, or 4 percent, to 11,239, after plunging 634 points Monday amid deepening fears about the economy.
The Fed’s continued focus on interest rates was tacit recognition that, given the nature of the economy’s present troubles, the central bank is not well-suited to play a central role in stimulating recovery.
The assessment of the overall outlook was a sharp reversal from earlier in the summer, when Fed Chairman Ben Bernanke suggested that the recovery was likely to pick up steam in the coming quarters — in part because of what he foresaw as the fading impact of temporary factors such as high oil prices and the supply-chain disruptions from Japan’s earthquake and tsunami.
Analysts attributed the stock market’s late rally Tuesday in part to the fact that the Fed took at least one step, however feeble, in a bid to ease the uncertainty and bolster the low confidence afflicting many investors, businesses and workers.
“Yes, it’s a dismal outlook,” said Diane Swonk, chief economist at Mesirow Financial. But in a market teeming with fatigue and confusion, she said, many investors apparently read the Fed statement as somewhat hopeful. “It’s still growth, it didn’t say double-dip (recession), and the Fed is going to fight it.”
The Fed statement said inflation had moderated as energy and other commodity prices have declined recently and that it expected a “subdued outlook for inflation” over the next two to three years.
But apart from low inflation and still-strong business spending for equipment and software, the Fed’s accounting of the economy was bleak, with deterioration in the labor market, flattened consumer spending, weak investment in commercial properties and a still-depressed housing market.
“Moreover, downside risks to the economic outlook have increased,” the statement said. Widening debt troubles in Europe, recent data indicating the U.S. recovery since 2009 has been considerably weaker than previously believed, and Standard & Poor’s downgrade of U.S. debt have further eroded confidence among investors and businesses.
The Fed made explicit that policymakers considered — and were prepared to act on — other policy actions. And some analysts said they expected the Fed would follow later this year with another round of large-scale bond purchases that could drive long-term interest rates even lower.
But many experts note that interest rates are not the economy’s real problem: That would be low demand for goods and services from both businesses and consumers.
As a result, most analysts don’t think additional bond purchases will do much more than add to the Fed’s already-bloated asset holdings, raising the risk of runaway inflation down the road.
In committing to near-zero rates through mid-2013, it was the first time that the U.S. central bank pegged a specific timetable to a pledge on its benchmark interest rate. Previously, the Fed had said it would maintain the federal funds rate, or overnight lending rate charged by banks, at such low levels for “an extended period.”
Three of 10 Fed committee members voted against the change in wording, saying they had preferred not to commit to a specific time period, presumably concerned that such easy-money conditions could pave the way for another asset bubble or spiraling inflation. The dissension could make it tougher for Bernanke to muster support in the months ahead for other potential policy changes to pump more money into the financial system in an effort to stimulate growth.
