Federal Reserve to scale back stimulus by $10 billion

Washington PostDecember 18, 2013 

The Federal Reserve announced Wednesday that it will scale back its multibillion-dollar stimulus program, a sign of its growing confidence in the nation’s economic recovery.

For more than a year, the central bank has been buying $85 billion in bonds every month in hopes of pushing down long-term interest rates and boosting demand among consumers and businesses. Starting in January, it will reduce that amount by $10 billion -- a small but symbolic first step toward unwinding its unprecedented support of the economy.

“In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the [Fed] decided to modestly reduce the pace of its asset purchases,” the central bank said in a statement.

The Fed currently is buying $40 billion worth of mortgage-backed securities and $45 billion in Treasury bonds every month. It will reduce purchases of each by $5 billion. The Fed said the program will likely wind down altogether in “measured steps” at future meetings but cautioned that the pace is not predetermined. If the recovery gains momentum, the central bank could reduce its stimulus more quickly. If the economy stumbles, the Fed could slow down -- or even increase its support.

Officials also stressed that the decision does not affect its commitment to keeping short-term interest rates near zero. The Fed has vowed that it will not raise rates at least until the unemployment rate reaches 6.5 percent or inflation climbs to 2.5 percent. But officials will likely hold off even longer: Documents released Wednesday showed the majority do not expect the first rate increase to occur until 2015, even though their unemployment threshold could be met next year. Three officials predicted the first increase won’t occur until 2016 - one more than in September.

Still, the decision to scale back the stimulus -- even by a little -- marks an important milestone in the country’s long road back from the Great Recession. The Fed has been criticized for ending earlier rounds of stimulus too early, and officials were determined not to make the same mistake again.

“When, ultimately, asset purchases do slow, it will likely be because the economy has progressed sufficiently,” Fed Chairman Ben S. Bernanke said in a speech in November.

Picking the right time to pull back has been difficult. The Fed tied the program to the health of the labor market but remained vague about what that meant. The picture was further clouded by confusing economic data, including a drop in the unemployment rate that was driven more by a shrinking workforce than a pickup in hiring. Meanwhile, a vocal minority of Fed officials raised concerns that the unconventional program could have unintended consequences, such as creating bubbles that breed financial instability.

In addition, the Fed’s attempts to prepare the markets and the public for the program’s inevitable end seemed to backfire. Stock markets plunged after Bernanke suggested this summer that the Fed would pull back by the end of the year. Interest rates also shot up, threatening the still-fragile housing market. Many investors then believed the Fed would move in September, but officials kept the program intact and cut their growth forecasts for the year.

The Fed’s outlook for economic growth next year has changed little since September. The nation’s gross domestic product is expected to grow between 2.8 and 3.2 percent next year, roughly in line with prior forecasts. But the unemployment rate is expected to drop more quickly, with predictions ranging between 6.3 and 6.6 percent for 2014. The Fed slightly lowered its outlook for inflation as well.

The private sector seems to be picking up steam, averaging more than 200,000 new jobs since August. In addition, many of the headwinds facing the economy are finally beginning to diminish -- particularly those from Washington. Lawmakers are poised to approve a deal to fund the government through 2015, putting to rest the political brinksmanship that has roiled the economy for nearly three years. The bipartisan budget rolls back the sharp spending cuts known as the sequester and replaces them with other savings.

“Fiscal policy is restraining economic growth, although the extent of restraint may be diminishing,” the Fed said in its statement.

One official dissented from the decision. Boston Fed President Eric S. Rosengren said the reduction in bond purchases was “premature.”

The Fed will meet again at the end of January and will likely discuss whether any additional reductions are necessary. At that point, the central bank will also be facing a change in leadership. The Senate is likely this week to confirm Janet Yellen, currently the Fed’s second-in-command, to succeed Bernanke when his term ends Jan. 31.

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