WASHINGTON – The Federal Reserve on Tuesday portrayed the U.S. economy as slightly healthier and held off on any new steps to boost growth.
Hiring is picking up and consumers are spending more despite slower growth globally, the Fed said in its policy statement issued after its final meeting of the year.
However, Fed officials cautioned that business investment has slowed and unemployment remains high. And they warned of strains in global financial markets that pose a threat to the world’s economy — a reference to Europe’s debt crisis. They left open the possibility of taking new steps next year if the economy worsens.
The Dow Jones industrial average closed down 66 points for the day, after being up by as much as 126 points before the Fed issued its statement. Broader indexes also ended the day lower.
The Fed made only slight changes to November’s statement. The policy committee approved it by an identical 9-1 vote. Charles Evans dissented for the second straight meeting, arguing again for more action by the Fed.
Still, the modestly upbeat statement appeared to disappoint investors and triggered the late-afternoon slump on Wall Street. Traders had hoped the Fed would announce new policy action, even though most economists expected none.
“The Fed did exactly what the markets were expecting, which is nothing, so the market decline is puzzling,” said Mark Zandi, chief economist at Moody’s Analytics. “It is always possible that there was some outside hope the Fed would do more to support the economy at this meeting and when the markets didn’t get that, they fell.”
Many economists said Fed policymakers likely spent their final meeting of the year fine-tuning a strategy for communicating changes in interest rates more explicitly. The Fed has left rates near zero for the past three years. More guidance would help assure investors, companies and consumers that rates won’t rise before a specific time.
The Fed made no mention of a new communications strategy in its statement. But economists say it could be unveiled as soon as next month, after the Fed’s Jan 24-25 policy meeting.
Diane Swonk, chief economist at Mesirow Financial, said the November minutes showed the Fed discussed adding an interest rate forecast to its quarterly economic projections.
Swonk said the Fed may be trying to build a stronger consensus before announcing the change. She also noted that three Federal Reserve regional bank presidents who opposed key policy changes this year will not have votes next year.
Charles Plosser of Philadelphia, Richard Fisher of Dallas and Narayana Kocherlakota of Minneapolis all dissented from the Fed’s policy statements in September and August after citing concerns that the actions introduced at those meetings could fuel inflation.
In September, the Fed said it would re-arrange its bond holdings to stress longer-term maturities, to try to exert more downward pressure on long-term rates.
That followed the Fed’s announcement in August that it planned to keep its benchmark rate at a record low until at least mid-2013, as long as the economy remains weak. It was the first time it had committed to keeping the rate there for a specific period. The Fed repeated that timeframe in its December policy statement.
“I think the Fed will shift its communications policy once the most vehement dissenters rotate off in January,” Swonk said. Each year, only five of the 12 regional bank presidents have votes.
Fed officials are debating how much further to go to signal a likely timetable for any rate changes. Under one option, the Fed would start forecasting the levels it envisions for the funds rate over the subsequent two years. It could publish this forecast, as it now does its economic outlook, four times a year.
Doing so would help assure investors, companies and consumers that rates won’t rise before a specific time. This might help lower long-term yields further — in effect providing a kind of stimulus.
Some worry that such guidance risks inhibiting the Fed’s flexibility to revise interest rates if necessary. Others counter that the Fed wouldn’t hesitate to shift rates if warranted. And they say the benefits of clearer guidance outweigh any constraints it might impose.
The Fed is also discussing setting an explicit target for “core” inflation. Core inflation excludes the volatile categories of energy and food. It’s remained historically low — currently around 1.5 percent by one measure.
The economy, while improving, is still weak. And it remains vulnerable to the European debt crisis, which could push the continent into a recession and slow U.S. growth. On Nov. 30, the Fed joined other central banks in making it easier for banks to borrow dollars. The goal is to help prevent Europe’s crisis from igniting a global panic.
Should the U.S. economy worsen, the Fed could take bolder steps, such as buying more mortgage securities. Doing so could help push down mortgage rates and help boost home purchases. The weak housing market has been slowing the broader economy.
The boldest move left would be a third round of large-scale purchases of Treasury securities. But critics say this would raise the risk of future inflation. And many doubt it would help much anyway, because Treasury yields are already near historic lows. Unless Europe’s crisis worsens and spreads, few expect another program of Treasury purchases.
