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Fed keeps key interest rates steady despite board member's disapproval

January 28th, 2010 12:48 PM by Lehel S.

Fed keeps key interest rates steady despite board member's disapproval

Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City, Mo., dissents from the central bank's action to keep interest rates at near zero for 'an extended period.' He calls it 'unwarranted'.

Reporting from Washington - As Federal Reserve Chairman Ben S. Bernanke appeared to gain enough backing for confirmation to a second term, the central bank offered a more upbeat assessment of the economy than it did last month but still affirmed a pledge to keep interest rates near zero for "an extended period."

For the first time in a year, however, the Fed rate-setting panel's statement, issued at the end of a two-day meeting Wednesday, came with a dissenting vote, which could presage an earlier-than-expected move to raise rates.

Thomas M. Hoenig, head of the Federal Reserve Bank in Kansas City, Mo., voted against the position taken by the 10-member panel. He argued that conditions had improved enough to make keeping the Fed's benchmark short-term rate near zero for an extended period unwarranted.

Some analysts interpret "extended period" as at least six months. And Hoenig's opposition didn't seem to change most economists' forecasts that the Fed would probably begin to raise its key rate late this year. That rate indirectly affects the rates on many credit cards, auto loans and home equity lines of credit.

Still, Hoenig's vote could foreshadow a shift in the Fed's thinking regarding inflation.

"Dissents at a Fed meeting often can become mainstream policy in the meetings to follow," wrote Chris Rupkey, an economist at the Bank of Tokyo-Mitsubishi in New York.

Diane Swonk, chief economist at Mesirow Financial in Chicago, played down the significance of the opposing vote, saying the consensus at the Fed was clearly driven more by worry about the durability of the economy than by concern about the risk of inflation.

The Fed, while indicating that the U.S. economy was in recovery, said the pace of economic activity was "likely to be moderate for a time," with consumer spending constrained by a weak labor market.

"The more critical issue for the future of monetary policy," Swonk said, "is that the Fed maintains its independence, which is being challenged on all sides."

At the center of this battle is Bernanke, whose four-year term as chairman expires Sunday. Over the last year he has been under fire from lawmakers and other critics who blame him and the central bank for bailing out big financial institutions while not doing enough to protect ordinary borrowers and the economy. After last Tuesday's Republican victory in a U.S. Senate race in Massachusetts, widely seen as a populist repudiation of Washington politics, even more senators stepped forward in opposition to Bernanke, abruptly lowering the odds of his reappointment.

Bernanke's defenders, who include President Obama, credit the chairman for taking bold steps that they say helped resuscitate financial markets and lift the economy after its free fall. And after lobbying by the White House, and Bernanke's calls and visit to Capitol Hill in recent days, it appeared that the 56-year-old chairman had enough votes to win confirmation. A Senate vote is scheduled for today.

Even so, lawmakers' attacks and populist uproar directed at the Fed have bruised its reputation and could still lead to greater congressional oversight -- or political influence, some say -- over the institution. Pending bills in the House and Senate seek to shed more public light on the Fed's lending and other activities, including the setting of monetary policy.

"Regardless of whether it's Bernanke or somebody else [as chairman], clearly there's been a major ding in the armor of the Federal Reserve," Swonk said.

But Fed critic Rep. Ron Paul (R-Texas) said this week that it would probably be back to business as usual for the central bank after the firestorm over Bernanke and the Fed settled. Paul also predicted that his popular proposal to audit the Fed would be watered down as a financial regulatory overhaul moved through Congress.

Nonetheless, Paul said, the financial crisis and the resulting broadsides against the Fed have awakened the public to the traditionally secretive institution and its policies. That, he said, "does not diminish the interest of the American people."

The specter of political influence weighs on the Fed as the economy faces a critical juncture. Technically, the country's economic output has been growing since last summer, and the government is expected Friday to report that the economy expanded in the fourth quarter at an annualized rate of 5% or more. But that solid pace isn't expected to last, and with the unemployment rate in double digits and the nation still shedding jobs, many Americans don't feel the economy is getting much better.

At the moment, policymakers see very little threat of inflation, which has been running below the Fed's target of 2%. But with massive federal deficits adding to the risk of long-term inflation, Hoenig and others in his camp are likely to urge for tightening monetary policy sooner than expected.

The Fed reiterated Wednesday that some emergency lending programs established during the recession would end Monday because the credit markets targeted by the programs had stabilized.

The central bank reaffirmed that it expected to complete by March 31 its purchase of $1.25 trillion in mortgage bonds in what has been a successful bid to drive down home-loan rates. But with some economists concerned that the program's termination will damage the housing recovery by boosting mortgage rates, the Fed left open the possibility that the program could go beyond March if warranted.

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Posted by Lehel S. on January 28th, 2010 12:48 PM

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