It also said business spending on equipment and software has risen significantly, also an upgrade from its last assessment. Still, the Fed cautioned that spending by consumers could be dampened by high unemployment, sluggish income growth, lower wealth and tight credit.
"The Fed painted the economy in a slightly brighter shade," said Stuart Hoffman, chief economist at PNC Financial Services Group. "It's been painted black for so long. Now, it is a lighter shade of gray."
The Fed's decision to pledge again to keep record-low rates for an "extended period" relieved investors. The Dow Jones industrial average gained about 30 points. Before the announcement, it had posted a gain in the single digits.
Prices for Treasurys rose slightly. The yield on the benchmark 10-year Treasury fell to 3.66 percent from 3.68 percent just before the announcement.
The Fed made no changes to a program to drive down mortgage rates and bolster the housing market, even as a government report Tuesday showed housing construction tumbling in February.
Under that program, the Fed is scheduled to end its mortgage-securities purchases from Fannie Mae and Freddie Mac at the end of this month. Some analysts fear that once the program ends, mortgage rates could rise. That could weaken the recovery in housing and the overall economy. The Fed has left the door open to extending the program if the economy weakens.
Hoffman thinks 30-year fixed mortgage rates, hovering around 5 percent, could rise to around 5.25 percent to 5.5 percent after the Fed program ends. That increase also would reflect stronger demand for mortgages as people rush to take advantage of a homebuyer tax credit that expires at the end of April.
The average rate on 30-year fixed mortgages dipped to 4.95 percent last week, from 4.97 percent a week earlier, according to mortgage finance company Freddie Mac.
The Fed's decision to keep record-low rates for an "extended period" -- thought to mean at least six more months -- again drew one dissent. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, for a second straight meeting opposed keeping the yearlong pledge.
Hoenig's dissent illustrates the Fed's challenge in deciding when to signal that higher rates are coming. Hoenig thinks the economy is strong enough for the Fed to telegraph that rates will rise soon to prevent inflation.
But Fed Chairman Ben Bernanke and other colleagues think the low rates will continue to be needed to feed the economic recovery. They held the Fed's target range for its bank lending rate at zero to 0.25 percent, where it's been since December 2008. In response, commercial banks' prime lending rate, used to peg rates on certain credit cards and consumer loans, has remained about 3.25 percent -- its lowest in decades.
Super-low rates benefit borrowers who qualify for loans and are willing to take on more debt. But they hurt savers. Low rates are especially hard on people living on fixed incomes who are earning measly returns on savings.
Once the recovery is more entrenched, the Fed will need to signal that higher rates will be coming.
To do that, the Fed could drop its commitment to keep rates at record lows for an "extended period." Or it could pledge to keep rates low only for "some time" or vow to keep "policy accommodative." Or it could change its language in some other way to stress that credit will be tightened when the time is right.
Any such step would signal that the days of easy money are fading.
Hoenig has been pushing to change the signal. At the Fed's last meeting in late January, Hoenig favored saying rates would stay low for "some time." He thought that would give the Fed more flexibility to start raising rates.
Hoffman and some others say they don't think the Fed will signal a change toward higher rates until early summer, with a rate increase to follow in the fall. The Fed's next meeting is in late April.