The Federal Reserve is famous for its verbal acrobatics, but it is now facing a particularly high hurdle: convincing the markets that doing less actually means doing more.
On Wednesday, Eric Rosengren, the president of the Federal Reserve Bank of Boston took his whack at that delicate task.
Let's back up. Since September, the central bank has been buying $85 billion in bonds every month, aiming to lower long-term interest rates and boost economic growth. There are signs that it is working – the Dow is at a record high and the housing market is bumping – and the Fed has promised to keep the money flowing until there is “substantial improvement” in the job market.
It looks like we’re getting close to that point. Job growth has averaged 200,000 a month for the past six months, and the unemployment rate has dropped a three-tenths of a percent since the program started. Fed officials are now starting to think about how to end the program – and opening a whole new can of worms in the process.
Fed Chairman Ben S. Bernanke has tried to prepare the markets for a gradual retreat, one that frequently takes the pulse of the economy along the way. The Fed could even do an about-face if the recovery starts to stumble. Officials are using words like “flexible,” “variable” and “calibration.”
But the Fed is worried that as soon as it slows down its bond-buying, the markets will act as if the shop is closed for business, negating the benefits of any stimulus the central bank is still providing. Bernanke has tried to dispel that notion by framing a reduction in purchases as simply a slowdown of the rate of Fed stimulus, rather than actually doing less to stimulate the economy. Tapering, Fed leaders want the world to understand, is not tightening.
Markets don't seem persuaded; mortgage interest rates spiked last week to a 12-month high of 3.71 percent amid worries that the Fed was preparing to wind down its purchases, That’s exactly what officials don’t want to happen.
On Wednesday afternoon, Rosengren, among the most dovish Fed officials, took another crack at explaining the thinking in a speech before the Economic Club of Minnesota:
“Thus the effect of our purchases ultimately depends on whether they result in a larger or smaller balance sheet for the central bank, which in turn depends on when the purchase program ends, given the pace of purchases. If asset purchases at a lower rate were to continue for longer than they would otherwise, the Fed’s balance sheet could actually grow larger than it would with more sizable purchases over a shorter period.”
Translation:Smaller monthly bond purchases could actually add to the balance sheet if the Fed sticks with the program for a longer period of time.
The consensus at the Fed holds that it’s not the rate of purchases that matters to the economy but the total amount of them. Rosengren’s comments signal yet another way the Fed could tailor its bond purchases to the economy and do more with less. Maybe not only is tapering not the same as tightening, but tapering could eventually lead to more easing.