Fed open to linking rate hike to economic gauge

[October 05, 2012]  WASHINGTON (AP) -- The Federal Reserve wants to find a clearer way to signal to the public when it might start raising interest rates.

The Fed has told investors that it plans to keep short-term rates low for at least another three years. But it appears to be leaning toward setting a more specific target, according to minutes from the Fed's last policy meeting.

Most members agreed at the Sept. 12-13 meeting that linking a future rate increase to a level of unemployment or some other numeric target could be useful. The minutes show members have yet to agree on what the economic target should be. But the discussion signals another option the Fed might pursue if its latest stimulus efforts don't do enough to boost the still-weak economy.

After last month's meeting, the Fed said it planned to keep its benchmark short-term rate near zero until mid-2015, six months later than it previously planned. And it left open the possibility of taking other steps.

The Fed also agreed at the meeting to spend $40 billion a month to buy mortgage-backed securities to drive longer-term interest rates lower and boost economic growth.

The Fed has kept the short-term rate at a record low since December 2008. In August 2011, it announced that it planned to keep the rate that low until at least mid-2013. It later extended the target date to late 2014. Last month, it extended it again to mid-2015.

This action has been intended to help the economy by assuring borrowers and investors that loans would remain cheap for years.

Numeric targets now appear to be under consideration to provide additional guidance on future interest-rate moves. But the minutes noted that the Fed would have to reach agreement on what those targets should be.

Charles Evans, president of the Fed's Chicago regional bank, has been the most vocal supporter of the change. He says the Fed should hold off on raising rates until the unemployment rate falls below 7 percent, as long as inflation doesn't exceed 3 percent.

And Narayana Kocherlakota, president of the Minneapolis Fed, said last month that he thought the Fed should pledge to keep rates low until unemployment falls below 5.5 percent -- a level Kocherlakota said could take four years or more to achieve.

Some members oppose such moves. They argue that by tying a rate hike to a level of employment, it raises the risk of leaving rates too low for too long, which heightens the threat of inflation.

On Monday, Chairman Ben Bernanke sought to reassure investors about the Fed's timetable for keeping its short-term rate ultra-low. The plan doesn't mean the Fed expects the economy to be weak through 2015, Bernanke said in a speech to the Economic Club of Indiana. Rather, he said policymakers plan to keep rates low well after the economy strengthens.

The minutes also showed that the Fed structured its latest stimulus program around the purchase of mortgage bonds. It did so after members agreed that helping a nascent housing recovery was a good way to lift the broader economy.

Many participants agreed at the meeting that more bond purchases would support the economy by putting downward pressure on longer-term rates. That encourages more borrowing and spending, which drives growth.

According to the minutes, Fed members compared the effectiveness of buying Treasury bonds to that of mortgage-backed securities.

"Some participants suggested that, all else being equal, (mortgage bond) purchases could be preferable because they would more directly support the housing sector, which remains weak but has shown some signs of improvement of late," according to the minutes.

A few members expressed skepticism that additional bond purchases would help, while also expressing concerns about inflation.

The average rate on the 30-year fixed mortgage has been below 4 percent all year. This week the rate fell to a record low of 3.36 percent. While home sales are rising, they remain well below healthy levels.

[Associated Press; By MARTIN CRUTSINGER]

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