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The Boston Globe


Fed to ease off stimulus with $10b cut

WASHINGTON — The Federal Reserve said Wednesday that it would gradually end its bond-buying program during 2014, a modest first step toward unwinding the central bank’s broader stimulus campaign as its officials gain confidence the economy is growing steadily.

The Fed plans to cut its monthly purchases of Treasury and mortgage-backed securities from $85 billion in December to nothing by the end of next year in a series of small steps, starting with a reduction to $75 billion in January, the central bank announced after a two-day meeting of its policy-making committee.

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At the same time, the Fed sought to offset concerns that it was once again pulling back too soon by strengthening its plans to hold short-term interest rates near zero, which officials regard as a more powerful means of stimulating growth. Both policies aim to hold down borrowing costs and revive risk-taking.

The Fed’s shift in policy, in effect, means it plans to do less now and more later. That is the result of a compromise that has been months in the making between a group of officials convinced that the economy needs more help and a range of internal critics who regarded the bond-buying campaign as ineffective or dangerous.

The Fed’s chairman, Ben S. Bernanke, insisted that the net effect was not a withdrawal of support for the economy.

“We are not doing less,” he said at a news conference Wednesday. “I think we have been aggressive to try to keep the economy growing, and we are seeing progress in the labor market. I would dispute the idea that we are not providing a lot of accommodation to the economy.”

Investors appeared to agree with Bernanke, defying predictions that stock prices would retreat along with the Fed’s pullback. Major stock indexes spiked when the Fed’s statement was released at 2 p.m., and the Standard & Poor’s 500 stock index rose 1.7 percent by the end of the trading day.

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Importantly, interest rates on benchmark bonds — the rates the Fed is trying to influence — ended the day roughly where they started. One reason for investor enthusiasm, said Michael Hanson, senior economist at Bank of America Merrill Lynch, is the stimulus will be withdrawn very gradually.

The markets now have a clear — though tentative — schedule for the course of Fed policy over the next two years, including an end to asset purchases by late next year and a signal from Bernanke that the first increase in short-term interest rates is not likely to come until near the end of 2015. That is particularly striking because the plan, set in the final months of Bernanke’s tenure, will now define the first two years of the term of his successor, Janet Yellen, whom the Senate is expected to confirm this week. Bernanke said Wednesday that Yellen “fully supports what we did today.”

The Fed is struggling to calibrate its stimulus campaign in an environment of steady but mediocre growth. The unemployment rate has declined over the past year, reaching 7 percent in November. But that is still a high rate by historical standards, and other measures of the labor market look even worse. Wages are rising slowly, and the share of adults with jobs has not climbed since the recession.

A variety of indicators suggest the US economy may now be growing more quickly than analysts predicted, and Fed officials anticipate somewhat faster growth in the coming year. But the persistence of low inflation indicates the economy is operating well below capacity.

“The committee is determined to avoid inflation that is too low, as well as inflation that is too high,” Bernanke said.

Some analysts saw an inconsistency between that rhetoric and the Fed’s shift, however.

“The Federal Reserve essentially disregarded the trajectory of inflation in this decision,” wrote Tim Duy, an economist at the University of Oregon.

Over the past year, the Fed has bought more than $1 trillion in Treasury and mortgage-backed securities in its effort to encourage job creation. Fed officials say the purchases have modestly reduced a range of borrowing costs, contributing, for example, to a rise in auto sales and an improving housing market. They say the program has also helped to revive an appetite for taking risks, driving up stock prices.

The Standard & Poor’s 500 and Dow Jones average hit new highs Wednesday, easing concern that investors would react badly to Federal Reserve plans to scale back the stimulus program. The S&P 500 gained 1.7 percent; the Dow, 1.8 percent.

Carolyn Kaster/AP/file

The Standard & Poor’s 500 and Dow Jones average hit new highs Wednesday, easing concern that investors would react badly to Federal Reserve plans to scale back the stimulus program. The S&P 500 gained 1.7 percent; the Dow, 1.8 percent.

“The ripple effects go through the economy and bring benefits to, I would say, all Americans,” Yellen said at her confirmation hearing.

But independent analysts have struggled to isolate the effects of the program. Some Fed officials, and outside analysts including some at the International Monetary Fund, see evidence that the impact of the bond buying has diminished as markets have returned to normalcy.

Officials are increasingly concerned as well about the potential consequences, including the disruption of financial markets and the difficulty of unwinding the program.

Fed officials also are frustrated that the bond-buying program has become a source of financial instability as investors hang on every shift in policy. Those concerns were reflected in the Fed’s decision to announce not just an initial cut in bond buying, but a probable timetable for ending the purchases completely.

The policy shift won the support of Esther L. George, the president of the Federal Reserve Bank of Kansas City, who has dissented at each previous meeting this year over concerns that the Fed was doing too much. But with the balance swinging in favor of her views, the decision drew a dissent from Eric S. Rosengren, the president of the Federal Reserve Bank of Boston, who called it premature.

The decision won broad support from the policy-making committee, including most proponents of the overall stimulus campaign, because of the decision to strengthen the Fed’s commitment to hold down interest rates. Wednesday’s announcement went well beyond the previous declaration of an intent to keep rates near zero at least as long as unemployment remains above 6.5 percent. The Fed said instead that “it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6½ percent, especially if projected inflation continues to run below the committee’s 2 percent longer-run goal.”

Some economists doubt the power of such guidance, however, including Stanley Fischer, whom the White House plans to nominate as Yellen’s vice chairman.

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