Wednesday, December 12, 2012

Breaking News ...The Fed Ties Interest Rates to Unemployment Rate ... Good Omen for Stock Prices

The Federal Reserve today acted in historic fashion by connecting its interest rate policy to achieving a 6.5% unemployment rate.

That explicit tie between interest rates and uemployment has never been done before and suggests that the current record low interest rates will remain in effect for at least several more years.

In turn that's a clear signal to investors to buy stocks, and especially dividend payers and growers.

Fed now sides with unemployed has the breaking news story:

"The Federal Reserve surprised almost everyone on Wednesday when it announced a major change in how it will conduct monetary policy.

For the first time, the Fed has announced a goal for the unemployment rate. By saying that it anticipates that it will keep interest rates extremely low until the unemployment rate falls to 6.5% (and as long as inflation doesn’t get out of control), the Fed has become more aggressive about turning the economy around. Read Fed to buy more bonds as it sets jobless target.

The new policy amounts to complete reversal from the days when Fed officials prided themselves on their inscrutability. Fed policy has now become an open book, as predictable as the tides.

The Fed has long been tasked with two main responsibilities: Full employment and price stability. For years, Fed officials refused to be pinned down on exactly what those terms meant, on the grounds that flexibility was more valuable than precision.

But leading macroeconomists have been arguing that monetary policy can be more effective if the Fed gives precise numerical targets for unemployment and inflation. Clear communication actually makes the policy work better, they said. Today, the Fed agreed with those critics. Read Why the Fed’s words mean more than its actions.

A year ago, the Fed announced that price stability could be defined as a 2% annual increase in consumer prices. And today, the Fed announced that full employment (in this economy) means a jobless rate of 6.5% or less.

Furthermore, the Fed said it would allow inflation to run a little faster than its 2% target as long as unemployment remains too high.

This is a reversal of nearly 100 years of Fed policy that had accorded paramount importance to price stability at the expense of concerns about shortfalls in employment and growth. Now, the Fed has said that it will give equal time to inflation and growth.

In the current economy, that means the Fed is now unambiguously siding with the unemployed. The Fed is finally taking its full-employment mandate seriously.

That’s good news. The bad news is that the Fed has already done almost everything it can to get the economy up to full speed. The new policy announced Wednesday will likely give the economy only a slight boost."

Summing Up

This is definitely good news. And it indicates that aggressive steps will be taken by the Fed to do all it can do, however limited its powers may be, to help our economy grow at a faster pace as well.

It also signals, at least to me, that the politicians aren't about to let the country go over the fiscal cliff at year end. Just about everybody has now admitted that our nation's economic growth and fiscal issues are too severe to be playing silly political games at this time.

So while things will remain slow, we can expect a seriousness of purpose and perhaps even a tinge of bipartisanship as we come to grips with the absolute necessity to get our economy growing at a rate substantially faster than its current trajectory.

My back of the envelope math says we'll need to get the monthly rate of jobs creation up to 200,000 from its present trend of 150,000, and then keep it there for several years before interest rates can return to anything close to what we used to call normal.

Without creating new jobs at an average monthly rate of 200,000, a 6.5% unemployment rate won't come about for a long, long time, if ever.

It's time to do everything possible to grow the economy faster, keep inflation low and get our fiscal house in order at the same time.

A tall order? Yes.

But it's an absolutely imperative one, too.

Thanks. Bob.

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