Fed keeps stimulus, says taxes and cuts have hurt

WASHINGTON -- The Federal Reserve cautioned America's political leaders Wednesday that their policies are hurting the economy.

The Fed stood by its aggressive efforts to stimulate the economy and reduce unemployment. But it sent its clearest signal to date that tax increases and spending cuts that kicked in this year are slowing the economy.

"Fiscal policy is restraining economic growth," the Fed said in a statement after a two-day policy meeting.

The Fed maintained its plan to keep short-term interest rates at record lows at least until unemployment falls to 6.5 percent. It said it will continue to buy $85 billion a month in Treasury and mortgage bonds. The bond purchases are intended to keep long-term borrowing costs down and encourage borrowing and spending.

The Fed's statement signaled its concern about a Social Security tax increase, which took effect Jan. 1, and deep government spending cuts, which began taking effect March 1. The across-the-board spending cuts took effect automatically after Congress failed to reach a budget deal.

Joel Naroff, chief economist at Naroff Economic Advisors, said he viewed the Fed's more forceful remarks on the issue as criticism of Congress' fiscal policies.

"The Fed noted that the private economy is pushing ahead, but it is the government that is putting roadblocks in the way," Naroff said. "That was as clear a shot at Congress as I have seen the Fed take."

Two years ago, Chairman Ben Bernanke argued at a Fed conference in Jackson Hole, Wyo., that Congress should do more to stimulate hiring and growth. Since then, Congress hasn't joined the Fed in acting to stimulate growth. Instead, congressional leaders have focused on deficit reduction and allowed tax increases and spending cuts to take effect.

The Fed made clear it could increase or decrease its bond purchases depending on the performance of the job market and inflation.

David Jones, chief economist at DMJ Advisors, said that in saying it could increase or decrease its bond purchases, the Fed wants to show flexibility: It's ready to respond, whether the economy improves or weakens significantly.

"I think the Fed is in a wait-and-see mode, like the rest of us," Jones said.

Jones said he expects no change in the level of bond purchases until September or later. The Fed wants time to see whether the economy can grow fast enough to drive sustained improvement in the job market, he said.

The Fed's statement appeared to cause little response in the stock market, which fell sharply on signs of a slowdown in hiring and manufacturing and weak earnings reports from some major companies. The Dow Jones industrial average sank 138 points, or nearly 1 percent.

Debate among Fed policymakers at their previous meeting in March had led some economists to speculate that the Fed might scale back its bond purchases if job growth accelerated.

But several reports in recent weeks have suggested the economy may be weakening. Employers added only 88,000 jobs in March, far fewer than the 220,000 averaged in the previous four months. On Friday, economists expect the government to report that employers added about 160,000 jobs in April.

The economy grew at an annual rate of 2.5 percent in the January-March quarter -- a decent growth rate but one that's expected to weaken in coming months because of the higher Social Security taxes and federal spending cuts.

At the same time, consumer inflation as measured by the gauge the Fed most closely monitors remains well below its 2 percent target. That gauge rose just 1 percent in the 12 months that ended in March. Low inflation gives the Fed room to keep interest rates low without igniting price increases.

The Fed has been joined by other major central banks in seeking to strengthen growth and reduce high unemployment.

The European Central Bank could cut its benchmark lending rate from a record low of 0.75 as soon as Thursday because the euro area's economy remains stagnant.

Unemployment for the eurozone is 12.1 percent. And the ECB predicts that the euro economy will shrink 0.5 of a percent in 2013.

Japan's central bank has acted to flood its financial system with more money to try to raise consumer prices, encourage borrowing and help pull the world's third-largest economy out of a prolonged slump. Economists say Japanese consumers will spend more if they know prices are going to rise.

The Bank of Japan has kept its benchmark rate between 0 and 0.1 of a percent to try to stimulate borrowing and spending. The Fed's goal is to keep price changes from hurting the economy. This could occur if inflation raged out of control or if the opposite problem -- deflation -- emerged. Deflation is a prolonged drop in wages, prices and the value of assets like stocks and houses.

The United States last suffered serious deflation during the Great Depression of the 1930s but Fed policymakers worry more about the threat of deflation any time prices go lower than 2 percent.

The Fed's action Wednesday was supported on an 11-1 vote. Esther George, president of the Kansas City regional Fed bank, dissented for a third straight meeting. The statement said George remained concern that the Fed's aggressive stimulus could heighten the risk of inflation and financial instability.