“Fed Study: Rate Peg Off Mark” WSJ 11/6/13

From the Wall Street Journal on November 6, 2013:  “Fed Study: Rate Peg Off Mark

Excerpts (emphases added):

The Federal Reserve could help drive down unemployment faster if it promised to keep short-term interest rates near zero for longer than currently envisioned by officials or investors, according to a new research paper by a top central-bank staff member.

Since last year the Fed has said it wouldn’t raise short-term interest rates, which are now near zero, until after the jobless rate drops below 6.5%, as long as inflation doesn’t exceed 2.5%. The unemployment rate was 7.2% in September; the October rate is due to be released Friday.

The research paper—written by William English, the head of the Fed’s monetary-affairs division and two other authors—argues the Fed’s unemployment threshold for rate increases would be more effective if it were lower than 6.5%, possibly as low as 5.5%. In effect that would mean waiting until the job market got much better before raising rates.

The paper lays out a range of scenarios that show short-term rates not rising until late 2015 but suggests an “optimal” policy might keep rates near zero as late as 2017. “Reducing the unemployment threshold improves measured economic performance,” the paper argues.

As part of the exercise, Mr. English relied heavily on computer forecasting models known as “optimal control” programs. That’s notable because these programs have also been cited by Janet Yellen, the president’s nominee to lead the Fed after Mr. Bernanke’s term expires, in speeches to defend the central bank’s easy-money policies.

**

The Fed is concerned that INFLATION IS TOO LOW and they would actually prefer inflation to be a bit higher.  They have made it quite clear that THE FED WILL KEEP THE FED FUNDS RATE NEAR ZERO for as long as the data permits, and current data and trends suggest this is likely to be at least well into 2015.

THE PREPONDERANCE OF EVIDENCE SUGGESTS INTEREST RATES ARE MORE LIKELY TO STAY IN A LIMITED RANGE THAN TO RISE SIGNIFICANTLY.

THE BURDEN OF PROOF IS ON THOSE WHO BELIEVE INTEREST RATES ARE GOING TO RISE.

Investors should focus on their LONG TERM STRATEGY to meet their LONG TERM GOALS AND OBJECTIVES, which in part means to minimize the perceived effects of short term events.  Such events include declines in the financial markets because they are both short term and temporary (not permanent).  Of course, this presupposes their long term strategy (basic asset allocation) is appropriate for their time horizon, risk profile, and other circumstances, and if not should be changed immediately.

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