Fed expects to begin stimulus pullback this year if recovery is steady

Federal Reserve Chairman Ben Bernanke says the fundamentals of the U.S. economy "look a little better to us," particularly the housing sector, which had been a drag on growth during the crisis.
June 19, 2013

The Federal Reserve expects to begin scaling back its massive economic stimulus later this year and end the program by mid-2014 if the recovery continues apace — delivering its clearest outline of its plans for the multibillion-dollar effort so far.

The Fed has been spending $85 billion a month to buy long-term bonds and boost the economy. The effort has been credited with propping up the housing market and fueling record highs in the stock markets.

But investors and ordinary home buyers alike have been speculating that the easy money will soon come to an end. The timeline provided by Fed Chairman Ben S. Bernanke on Wednesday was intended to address confusion over how the central bank will wean the economy from its support.

“It is important for us to communicate,” he said at a news conference. “We are determined to be as clear as we can, and we hope that you and your listeners and the markets will all be able to follow what we’re saying.”

Stock markets did not seem to like the message. The three major U.S. indexes plunged by more than 1 percent as investors confronted the eventual end of the Fed’s stimulus. The yield on 10-year Treasurys jumped nearly 8 percent amid a sell-off in the bond market. Most of the Fed’s purchases have been government debt.

Bernanke stressed that Fed officials will adjust their timeline for ending the bond purchases to the realities of the recovery. If the economy’s momentum was to evaporate, the Fed could slow or delay the wind-down of bond purchases. If the recovery was to take off, it could speed up the process.

“Our policy is in no way predetermined and will depend on the incoming data and the outlook,” Bernanke said.

He said he expects the unemployment rate to be about 7 percent when the Fed stops the program, down from the current 7.6 percent and a “substantial improvement” from the 8.1 percent jobless rate when the program began. Bernanke also predicted a pickup in economic growth over the next several quarters.

Overall, the Fed sounded a more optimistic note as it wrapped up its regular policy-
setting meeting in Washington on Wednesday. It pointed out that the risks to the economy have “diminished” since the fall. Bernanke cited the rebounding housing market and the weakening impact from tax hikes and government spending cuts as examples.

The Fed has said that tapering its bond-buying program would not mean it was ending its efforts to stimulate the economy. But the market reaction to Bernanke’s statements Wednesday suggested that investors do not share that view.

“So, in short, we now have more clarity around a policy that has not been definitively laid out but that also has not changed,” said Richard Moody, chief economist at Regions Bank. “It has been, is and will remain all about the evolution of the data.”

The slide in stocks underscored the challenges facing the Fed as it tries to articulate its plans for the future of the stimulus effort, one of the many unconventional tools the central bank has come to rely on since the financial crisis. The Fed has tied the program to improvement in the labor market but until Wednesday had not defined what that meant.

Bernanke stressed that there was no change in policy. Fed officials voted to continue buying long-term bonds at least until their next meeting, at the end of July. The Fed also did not detail how it would slow down the purchases or what conditions would prompt it to change course.

How and when to end the program has been a controversial issue inside and outside the Fed. In an unusual move, two officials dissented from Wednesday’s decision to keep the stimulus program intact.

Kansas City Fed President Esther George voted against it over concerns that the program is breeding financial instability. St. Louis Fed President James Bul­lard dissented because he believed officials should signal that they are willing to fight low inflation now.

The midpoints of Fed officials’ inflation forecasts dropped to 0.8 to 1.2 percent, from 1.3 to 1.7 percent. Low inflation eventually could cause economic stagnation, and Bullard has argued that should be reason enough for the Fed to expand its bond-buying program, rather than tying it to the job market.

In his remarks, Bernanke said that recent low inflation is temporary and that it will rise over the long run to meet the Fed’s target of 2 percent.

The Fed also sought to separate the guidance for its bond-buying program from its thresholds for changes to the benchmark interest rate. Officials have vowed to keep short-term rates low at least until unemployment reaches 6.5 percent or inflation hits 2.5 percent. Most Fed officials believe the first increase in rates will not occur until 2015; one predicted it will not happen until 2016.

Bernanke emphasized on Wednesday that the process will be measured. Diane Swonk, chief economist at Mesirow Financial, said the movements could even be “glacial.”

“It is critical to remember that tapering will be gradual, barring a major surge in economic growth, and that the Fed’s policy remains extremely accommodative,” she said.

Whether Bernanke will be there to guide the process remains unclear. During his seven years as chairman, he has overseen one of the most tumultuous periods in American financial history. President Obama recently said Bernanke had stayed in the job “longer than he wanted or was supposed to.”

But when asked Wednesday about his future, Bernanke sidestepped the question.

“I would like to keep the discussion questions here on policy,” he said. “I don’t have anything for you on my personal plans.”

Ylan Q. Mui is a financial reporter at The Washington Post covering the Federal Reserve and the economy.
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