Fed begins scaling back economic stimulus
By: MJ Lee
December 18, 2013 02:19 PM EST
The Federal Reserve announced on Wednesday that it will begin pulling back on its efforts to boost economic growth through monthly bond purchases, arguing the economy is gaining enough strength for the central bank to begin its retreat.
Financial markets have closely watched and speculated on when the Fed would begin scaling back its monthly bond buys, the central bank’s signature response to the recession brought on by the financial crisis, and the issue has also stirred political debate with Republicans charging the Fed is intervening too much in financial markets and the economy.
On Wednesday, the Fed said its policy setting committee has decided to “modestly” scale back the pace of its monthly asset purchases by $10 billion and will now buy $75 billion worth of Treasury and mortgage-backed bonds each month starting in January.
“In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases,” the Federal Open Market Committee said in a statement.
U.S. stocks rose sharply following the announcement, with the Dow Jones Industrial Average rocketing up almost 180 points higher than Tuesday’s close.
Fed Chairman Ben Bernanke said that because unemployment remains high at 7 percent, the central bank believes it should not abandon its bond buying program immediately. He also said that the Fed will likely work to keep short-term interest rates at current levels “well past” the point at which the unemployment rate dips below 6.5 percent.
“The recovery clearly remains incomplete,” he said following the announcement, emphasizing that there is no guarantee that the FOMC will announce a reduction in its asset purchases at each meeting next year. “If the economy slows for some reason or we are disappointed in the outcomes, we could skip a meeting or two. On the other side, if things really pick up we could go a bit faster.”
This will likely be Bernanke’s last news conference as chairman. He is set to step down on Jan. 31 with Fed Vice Chairwoman Janet Yellen expected to be easily confirmed by the Senate this week as his successor.
The Fed began its third round of quantitative easing in September 2012, and has been purchasing $85 billion in Treasury and mortgage bonds each month in an effort to keep long-term interest rates low and in hopes it will help the economy by encouraging spending and investing.
Analysts said the closely watched decision by the Fed to begin reducing the amount of bonds it buys each month – known as tapering - is the result of several positive economic indicators since September, when many Fed watchers were surprised by the announcement to hold off on tapering.
“They continue to cite both the labor market and other indications of real economic growth becoming real and sustainable, and I think clearly we’ve seen that lately,” said Jeffrey Kleintop, chief market strategist at LPL Financial.
The budget agreement that emerged from Capitol Hill this month has also helped to create a more stable political environment in Washington since September, when markets were rattled by the possibility of a government shutdown as well as a potential debt default.
While the debt ceiling must once again be raised in 2014, economists said taking another government shutdown off the table likely affected the Fed’s decision-making.
“They didn’t want to be tapering asset purchases and then have the economy slump due to the government shutdown,” said Carl Riccadonna, senior economist with Deutsche Bank. “We now have a budget deal, so the risk of a repeat of what we found in October happening again in January now seems to be significantly downplayed.”
Quantitative easing has drawn criticism from Republicans and some economists, who have expressed concerns that the program could lead to an inflation spike, although there has so far been little evidence prices will soon greatly increase.
On Capitol Hill, conservative lawmakers have increasingly made the Fed a political target and a symbol of government overreach. Earlier this month, House Financial Services Committee Chairman Jeb Hensarling (R-Texas) launched an examination of the Fed’s history and policies and vowed to introduce legislation to make changes to the central bank late next year.
FBR Capital Markets analyst Ed Mills said a December taper announcement takes significant political pressure off of Yellen.
“Allowing for that decision to be made while everyone is still fully comfortable with Ben Bernanke — and the markets respect him and have no question really about his judgment — frees up Yellen to not have to start off as chairman and make such a controversial decision,” Mills said.