The Federal Reserve began winding down its unprecedented efforts to stimulate the economy through quantitative easing Wednesday, capping months of speculation about the timing of the “taper” of its open-ended monthly bond purchases.
The Federal Open Market Committee, the Fed’s monetary policy group, announced in a statement following a two-day meeting that it would cut the size of its monthly purchases of Treasury bonds and mortgage-backed securities by $5 billion each, reducing the total amount from $85 billion to $75 billion. The committee declined to say how quickly it would phase out the rest of the purchases, saying that it "will likely reduce the pace of asset purchases in further measured steps at future meetings."
But the committee also boosted its other major stimulus effort, namely its commitment to keeping short-term interest rates near zero. Rates will be kept at zero until "well past the time that the unemployment rate declines below" 6.5 percent and especially if inflation remains low, according to the statement. That language represents an extension of the zero-rates promise that the Fed has made in past meetings.
Wednesday’s move signifies that the bond-buying program is on track to accomplish the goals that Fed Chairman Ben Bernanke and other Fed officials set out for it when it was started last year with the promise that it would continue until labor markets had improved “substantially.”
Over the course of the year, the unemployment rate has fallen steadily, from 7.8 to 7.0 percent. As early as June, Bernanke suggested that the central bank could begin scaling back the asset purchases in the following meetings.
But although the jobs outlook has improved, economic growth has not picked up as Fed officials anticipated it would. And inflation has consistently run below the Fed’s 2 percent target, a sign to officials of economic slack.
The result has been confusion over the Fed’s plans for slowing its stimulus programs — confusion that Bernanke admitted in a speech in November was partly because of his own miscommunications, including at a September press conference when he announced to the surprise of most investors that the Fed would delay the taper until further signs of improvement in the economy.
Bernanke and other Fed officials have been working to clarify their plans and avoid further market shocks like the ones that followed the June and September meetings, which Bernanke described as “neither welcome nor warranted” in November.
The minutes from the Fed’s October meeting show that officials agreed on the need to convince markets that tapering would not amount to tightening, and that the decision to raise interest rates from zero would be separate from — and come significantly later than — the taper.
To that end, the officials discussed the possibility of strengthening the guidance about interest rates to coincide with the taper. They considered a few options, including lowering the threshold for the first rate increase from 6.5 percent unemployment, or adding an inflation threshold, meaning that there would be no rate increase as long as inflation was below some cutoff point.
Following that meeting, Bernanke has worked to distinguish between tapering and tightening, and to bolster the Fed’s promise to keep rates at zero. In November, he said the Fed “can be patient” in waiting to raise rates after quantitative easing has been wound down, and noted that the taper would mean that the Fed would “rely more heavily on its rate policies” to improve monetary conditions.
Following those efforts by Bernanke to clarify the Fed’s intentions, Wednesday’s announcement marks a transition away from the historic quantitative easing program and toward a policy of forward guidance regarding interest rates meant to help restore the U.S. economy back to its pre-financial crisis strength.
With Wednesday’s announcement, Bernanke began ending the program he initiated before he leaves office. The press conference following the meeting is likely Bernanke’s last as Fed chairman. His term ends in January and the current vice chairwoman, Janet Yellen, is expected to be confirmed as his successor by the Senate this week.
Wednesday's statement had one dissenter among the 10 voting members: Eric Rosengren, the president of the Boston Fed known as a dove, said that a taper was "premature" until there is more evidence of the economy improving.