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October 10. 2013 9:20PM

Budget chaos keeps Fed interest rates low

WASHINGTON — Three years from now, Federal Reserve forecasters expect the economy will still be struggling to overcome one of the biggest obstacles to growth: U.S. fiscal policy.

Most Fed officials last month predicted drag from fiscal restraint, a slow recovery in housing markets, and tight credit would cause them to hold the benchmark lending rate at 2 percent or lower until the end of 2016 to support growth and job creation.

“It is harder to get to full employment when you are in fiscal chaos,” said Allen Sinai, chief executive officer at Decision Economics in New York. “They have to be easier longer. It makes them look like they are slaves to fiscal craziness.”

Policymakers’ interest-rate forecasts showed they were building long-term fiscal dysfunction into their outlook even before the partial federal government shutdown and impasse over raising the debt ceiling. Now, the wrangling in Washington is also pushing back the timeline for a reduction in bond purchases that would precede any increase in interest rates.

The shutdown has interrupted the flow of government data the Fed uses to evaluate the health of the economy, from factory orders to trade and unemployment. It also threatens to curtail economic growth after as many as 800,000 government workers were furloughed.

“The Fed is not going to taper while the government is shut down,” said Dean Maki, chief U.S. economist at Barclays Plc in New York. “One, there is a weight on the economy and, two, the Fed calls itself ’data dependent,’ and it’s hard to be data dependent when there’s no data coming out.”

Maki, a former Fed board economist, said the fiscal impasse means a decision to taper bond purchases when central bankers’ next meet Oct. 29-30 is “quite unlikely.” He predicts a reduction in the pace of bond buying in December, though he said “the fiscal uncertainty has put that at risk.”

Keeping the Fed’s $85 billion in monthly bond purchases in place protects the economy from the effects of the shutdown, according to Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis.

“Our accommodative policy is a useful buffer against these kinds of fiscal disturbances,” Kocherlakota, who votes on policy next year, said in an interview last week.

Atlanta Fed President Dennis Lockhart said on Oct. 3 the central bank’s surprise decision last month to maintain the pace of bond purchases was “wise” given the subsequent shutdown.

“We avoided a potentially very awkward situation of reducing stimulus just on the eve of what now has developed,” Lockhart told reporters at a conference in Atlanta.