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Fed to keep interest rate near zero for 2 years

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"The tone of the Fed's statement is very downbeat. They are very nervous about the economy," said Mark Zandi, chief economist at Moody's Analytics. "This is unprecedented for the Fed to indicate they are ready to keep rates low for two more years."

Federal Reserve headquarters, Washington. Photo: Dan Smith via Wikimedia Commons

Not everyone was as impressed as investors on Wall Street appeared to be. University of Oregon economist Timothy Duy called the move "weak medicine" and said he wanted to see the Fed commit to buying more Treasury bonds, a measure known as quantitative easing.

The Fed's projection of a weak economy into 2013 is also bad news for President Barack Obama, who must fight a re-election campaign next year. Already, some of Obama's Republican challengers have blamed the S&P downgrade on him. S&P itself blamed the country's long-term debt problems and dysfunctional politics.

Specifically, the Fed said the economy was "likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013." It held out the promise of further help down the road but did not spell out what else it might do.

The central bank's decision was approved on a 7-3 vote with three Fed regional bank presidents who have been worried about inflation objecting. It was the first time since November 1992 that as many as three Fed members have dissented from a policy statement.

Dean Maki, chief U.S. economist at Barclays Capital, said the dissent suggests that Fed Chairman Ben Bernanke would have trouble building consensus for another round of bond purchases.

The Fed used significantly more downbeat language to describe current economic conditions. It said so far this year the economy has grown "considerably slower" than the Fed had expected and consumer spending "has flattened out."

It also said that temporary factors, such as high energy prices and the Japan crisis, only accounted for "some of the recent weakness" in economic activity.

Bob Doll, chief equity strategist for asset manager BlackRock, shrugged off worries that a slow-growing U.S. economy would weaken the corporate earnings that underlie stock prices.

"Corporate America has demonstrated that it can generate good growth and profits despite a weaker U.S. economy," he said.

Companies have earned healthy profits despite a weak economy by expanding in faster-growing markets overseas and by squeezing more work out of reduced staffs in the United States.

Doll said the low yields on bonds make stocks irresistible. He noted that the yield on 10-year Treasury bonds is now lower than the dividend yield on stocks in the S&P 500 index "for the first time in my career."

The more explicit timeframe on the Fed's key interest rate is aimed at calming nervous investors. It offered them a clearer picture of how long they will be able to obtain ultra-cheap credit.

Bernanke didn't speak publicly after Tuesday's Fed meeting. He is expected to speak later this month at the Fed's annual retreat in Jackson Hole, Wyo., Bernanke will likely address the weakening economy, the S&P downgrade and the market turmoil.

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