US ties interest rate to level of unemployment

The US Federal Reserve will keep interest rates at close to zero until unemployment falls below 6.5 per cent, in a historic change to monetary policy.

It is the first time a large central bank has ever tied its interest rate policy directly to the state of the economy.

The Fed said it would continue to forecast low rates provided its inflation expectations do not rise above 2.5 per cent.

Mr Bernanke said at a news conference that the numerical thresholds for low rates would help “support household and business confidence and spending”, and noted that this would make monetary policy “more transparent and predictable” to the public.

However Mr Bernanke said the 6.5 per cent threshold on unemployment should not be interpreted as the Fed’s long-term natural jobless rate goal, which was significantly lower.

The Fed also beefed up its third round of quantitative easing to $85 billion a month – adding $45 billion of Treasury purchases to its commitment to buy $40 billion of mortgage-backed securities each month – and said it would keep buying until there was a substantial improvement in the labour market.

The changes mark an all-out effort to revive the stuttering economic recovery. They also signal that the central bank remains concerned about the “fiscal cliff” of tax rises and spending cuts that could be triggered next month, and has taken little heart from improved data on the housing market.

Mr Bernanke said the economy was already incurring “costs” from the threat posed by the looming fiscal cliff. He reiterated how damaging it could be for the US recovery, and said the Fed did not have the tools to offset its full impact, but could potentially increase the size of its asset purchases “a bit”.

The dollar came under pressure after the new Treasury purchases were announced.

With the unemployment rate at 7.7 per cent in November, the move signals low interest rates for the foreseeable future, and it replaces the Fed’s earlier pledge of low rates “at least through mid-2015”. – Copyright The Financial Times Limited 2012