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Fed promises ‘patient’ approach to rate hikes

WASHINGTON — The Federal Reserve is signaling that it’s edging closer to raising interest rates from record lows because of a strengthening U.S. economy and job market. But it is promising to be “patient” in determining when to raise rates.

The Fed said Wednesday after a two-day meeting that this “patient” approach is consistent with what it called its “previous” guidance that it expected to keep the rate near zero for a “considerable time.”

The Fed gave no specific guidance on when the first rate hike might occur.

Most private economists believe that the first rate hike will occur in June as long as the inflation outlook doesn’t remain persistently below its target rate of 2 percent. In an updated economic forecast, the Fed lowered its inflation forecast for next year to 1 percent to 1.6 percent.

The Fed’s action was approved on a 7-3 vote. The fact that three Fed officials dissented from the majority view was evidence of the internal battles inside the Fed at the moment as the central bank tries to transition from an extended period of ultra-low interest rates to a period when it begins to raise rates. The Fed has not raised rates in more than eight years.

The dissents included Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser, two of the Fed’s leading hawks, officials who believe the Fed needs to emphasize the fight against inflation more than the battle to boost employment. But Narayana Kocherlakota, president of the Fed’s Minneapolis regional bank, also dissented. He is a leading dove, an official who has pushed for more efforts to boost employment.

The Fed’s decision to move to a “patient” approach had been expected given the significant gains this year in the labor market. The economy created 321,000 jobs in November, keeping on track for the healthiest year for job growth since 1999, with the unemployment rate now down to 5.8 percent. That is close to the 5.2 percent to 5.5 percent unemployment rate that the central bank considers maximum employment.

The Fed is following the pattern it set in 2004 when it moved away from the phrase “considerable period” in January of that year and substituted “patient.”: It followed that in June with the first rate hike.

The Fed’s key short-term rate has been at a record low near zero since December 2008. When the Fed does begin raising rates, the expectation is that the rate increases will be a gradual process implemented with small quarter-point moves that will leave consumer and business interest rates at historically low levels for a considerable period.

At the previous meeting in October, the Fed brought to an end its third round of bond purchases. Those bond purchases have pushed the Fed’s holdings to close to 44.5 trillion, more than four times the level of the Fed’s balance when the financial crisis hit in the fall of 2008.

While it is not adding to those bond holdings, the Fed is maintaining the current record-high level which is continuing to exert downward pressure on long-term rates.

Supporters of the bond purchases defend them as a successful attempt by the Fed to use all tools at its disposal to battle the worst economic downturn the country has seen since the Great Depression of the 1930s.

But critics of the move contend that the Fed will find it difficult to sell off its massive holdings without jolting financial markets. They also worry that the sharp increase in the money supply that was a result of the bond purchases will at some point trigger unwanted inflation and potentially inflate dangerous asset bubbles.