Federal Reserve Warns That Super-Low Rates Could Fuel Speculative Bubble

November 25, 2009 - 5:36 AM
Record-low interest rates "could lead to excessive risk-taking in financial markets," according to Fed documents released Tuesday.  Low rates also could prompt worries about inflation.
Washington (AP) - The Federal Reserve doesn't expect the recovery will be strong enough to quickly drive down the jobless rate, and acknowledged its efforts to keep the rebound going could feed a new speculative bubble.
 
Record-low interest rates "could lead to excessive risk-taking in financial markets," according to documents released Tuesday of the Fed's closed-door meeting earlier this month. It also could cause consumers, investors and businesses to worry about inflation taking off.
 
Although Fed officials saw the current likelihood of that as "relatively low," they pledged to "remain alert to these risks."
 
At the Nov. 3-4 meeting, Fed Chairman Ben Bernanke and his colleagues kept the target range for its bank lending rate at zero to 0.25 percent.
 
Fed policymakers also pledged to hold rates at such super-low levels for an "extended period," to ensure the recovery gains traction. Most analysts predict that means rates will stay where they are through the rest of this year and into part of 2010.
 
On the economy, the Fed expects the unfolding recovery will be gradual, as modest growth keeps the nation's unemployment rate elevated over the next several years.
 
Most Fed policymakers said it could take "five or six years" for the economy and the labor market to be consistently healthy.
 
High unemployment, slow income growth and hard-to-get credit will weigh on consumer spending "for some time to come," the Fed said. Troubles in the commercial real-estate market also will restrain the recovery, according to minutes of the November meeting.
 
Fed officials expected the pace of the recovery "would be rather slow, relative to historical experience." Recoveries after steep economic downturns are usually robust, the Fed said.
 
In updated economic projections, the Fed said the economy's contraction for all of this year won't be as deep as it thought in a forecast released in the summer. That's because the second half of this year is shaping up better than anticipated.
 
Under a range of new projections, the economy will shrink 0.5 percent or be flat this year. The old forecast called for a contraction of anywhere from 0.6 to 1.6 percent.
 
Growth next year should turn out slightly better than the Fed previously projected-- ranging from 2 to 4 percent -- up from 0.8 to 4 percent.
 
But that won't be enough to quickly drive down the unemployment rate, which now stands at 10.2 percent. It's only the second time in the post-World War II period the rate has topped 10 percent.
 
The central bank predicted the jobless rate could hover between 8.6 and 10.2 percent next year, based on a range of forecasts from Fed policymakers. It's a tad better than its previous forecast, where the Fed said the jobless rate could rise as high as 10.6 percent.
 
The postwar high was 10.8 percent at the end of 1982 when the country had suffered through a severe recession.
 
Looking ahead to 2011, the Fed said the unemployment rate could drop to anywhere from 7.2 to 8.7 percent. That would still be considered well above normal, which is between 5 and 6 percent.
 
"Most members projected that over the next couple of years, the unemployment rate would remain quite elevated," according to the Fed minutes.
 
Inflation, meanwhile, should stay under control, the Fed said.
 
Prices this year should increase between 1 and 1.7 percent, and rise a bit higher next year. The new projections were little changed from the old forecast.
 
The new projections buttressed economists' beliefs that Fed policymakers won't be in any rush to boost rates.
 
"So long as unemployment remains high and inflation expectations subdued, the Fed has little desire to lift rates," said Sal Guatieri, economist at BMO Capital Markets. "Since the November meeting, Fed speakers have turned decidedly dovish" likely because unemployment spiked to 10.2 percent just days after that gathering.