Why Federal Reserve will keep interest rate low? Its consequences?

Written by: Shoaib Zaman

Why Federal Reserve will keep interest rate low?
This was a surprise, while every one was considering that there will another round of quantitative easing from the Federal Reserve but it surprised by announcing to keep the interest-rate low for two years (till mid-2013). According to Greg Robb of Market Watch, this was not new, it is exactly what should have been expected. 

He writes that in a conference for academics and financial market participants sponsored by the University of Chicago, the Federal-Reserve Vice-Chairman Janet Yellen had said, that 'forward guidance' would be the next tool used by the central bank.

Yellen made statements to the effect that if there was substantial risk to the economic activity and inflation then forward guidance might well be sufficient to facilitate an outward shift in the expected path of the funds rate.

“If financial market participants appeared to be expecting policy firming to begin somewhat sooner than policymakers considered desirable or appropriate under such circumstances, the language of the forward guidance could be adjusted to shift expectations toward the somewhat longer horizon over which the Committee expected the federal funds rate to remain extraordinarily low." Yellen was quoted as saying.

A simulation using the Fed"s model of economic growth indicated that a shift in policy expectations would be associated with a lower trajectory for the unemployment rate and a somewhat higher path of core inflation over coming years, Yellen said.

Considering this little piece of information shows that the government is actually out of policy bullets, as stated by Nouriel Roubini the famous economist, and hence the measures are not sustainable. Building up confidence based on announcements does not change the facts.

In this case, the facts remain steady that United States is is over leveraged and it needs to correct itself. As that happens stock markets will once again fall, inflation would go up and the entire economy will either face stagflation or deflation.

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