Fed meeting is focusing on plan to forecast rates

Federal Reserve officials are expected to spend their final policy meeting of 2011 fine-tuning a strategy for communicating changes in interest rates more explicitly.

Many private economists don't expect any major announcement after the meeting Tuesday. But most think Fed officials will be completing a plan to forecast the direction of short-term rates starting next year.

Doing so would help assure investors, companies and consumers that rates won't rise before a specific time. The new communications strategy could be unveiled as soon as next month, after the Fed's Jan 24-25 policy meeting.

The Fed has kept its key rate, the federal funds rate, at a record low of between zero and 0.25 percent for three years. But the economy, while improving, is still weak.

Unemployment remains high at 8.6 percent. The Fed is still considering ways to keep downward pressure on long-term rates. The goal is to encourage consumers and businesses to borrow and spend more and invigorate the economy.

In addition to debating the new communications plan Tuesday, the Fed will also discuss threats to the U.S. economy from Europe's debt crisis. But private economists say they think the Fed will delay any further support to the economy, such as additional bond purchases, to see if recent modest gains in U.S. activity will continue.

The Fed will issue a statement after the meeting ends. Chairman Ben Bernanke, who now holds quarterly news conferences, will next meet with reporters after the Fed's January meeting. At that time, the Fed will also update its economic forecasts.

The U.S. economy remains vulnerable, especially to the impact of the financial crisis and likely recession in Europe. So the Fed is keeping open its options for doing more to bolster the economy.

It's already taken numerous unorthodox steps. December, for example, will mark three years since it cut the funds rate to a record low. It's also bought more than $2 trillion in government bonds and mortgage-backed securities to try to cut long-term rates and lower borrowing costs.

Besides emboldening consumers and businesses to borrow and spend more, lower yields encourage some investors to shift money into stocks. This can boost wealth and spur more spending.

One possibility, should the economy worsen, would be for the Fed to buy 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.

Still, it can't be ruled out.

"Europe is going to be a big headache for quite a while," said Diane Swonk, chief economist at Mesirow Financial. "We are going to have a lot of icebergs to dodge, and if the situation dramatically deteriorates, the Fed will act."

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. The announcement sent the Dow Jones industrial average up nearly 500 points, its best day in 2½ years.

After its September meeting, 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. It was the first time it had committed to keeping the rate there for a specific period.

Now, 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.

"You could make investment decisions with more certainty," said Mark Zandi, chief economist at Moody's Analytics.

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.

Making a specific rate an official goal could anchor inflation expectations and guide investors on when the Fed might adjust rates to try to hit the inflation target. Such guidance would follow other steps to make the Fed more transparent that began under Chairman Alan Greenspan and have accelerated under his successor, Bernanke.