) -- Last year at this time, the Federal Reserve dropped its overnight lending rate, known as the fed funds rate, to the unheard of level of 0.25%.
Ultra-low borrowing costs were supposed to prop up the shaky economy by providing cheap capital to banks, which would spur lending and, as a result, increase consumer and corporate demand. Since then, the
has gained more than 20%, yet the economy is still fragile, prompting the Federal Reserve Open Market Committee to keep rates unchanged today. There won't be any changes soon, all indicators suggest.
Earlier today, a factor that's making super-low rates possible, the consumer price index, showed no change from October to November when excluding food and energy. Prices aren't climbing despite easy money and a huge amount of stimulus dollars circulating through the economic system.
The weak job market has helped to keep inflation at bay as retailers like
have indicated that price cuts have been necessary to spur sales. As it stands, the weak economy is keeping inflation under wraps, but trouble could come in 2010 if the recovery speeds up.
The Fed uses the fed funds rate like a throttle for the economy. When times are tough, a rate cut can spur demand, and when the economy begins to overheat, an increase can cool things off. The biggest concern is that low rates will lead to accelerating inflation, requiring the Fed to raise rates to keep the dollar from sliding and to prevent price increases from destroying the fragile recovery.
That's not an immediate concern. The Fed's policy has translated into mortgage rates that have fallen to less than 5% in many regions, which has boosted the badly struggling housing market. Thanks to low rates and the new homebuyer tax credit, housing starts in November rose 8.9% to an annually adjusted rate of 574,000 homes, according to a report today. Mortgage rates should stay at rock-bottom levels, helping to make purchasing a home more affordable.
will walk a tight rope in trying to stimulate the economy while keeping the dollar strong. With the U.S. currency continually losing value, most economists think faster inflation is inevitable. For now, however, rates are low, and demand is just starting to strengthen.
-- Reported by David MacDougall in Boston.
Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.