Fed Starts Rollback Of Rescue Efforts

By Neil Irwin
Washington Post Staff Writer
Thursday, August 13, 2009

With the recession easing, the Federal Reserve reached a milestone Wednesday after two years of unprecedented intervention in the economy: It began the pullback.

The Fed said that in October it will wind down a program to buy U.S. government bonds, a first step in what could be a multi-year high-wire act. The central bank seeks to remove its expansive efforts to support the economy soon enough to prevent inflation but not so soon that the fragile recovery is quashed.

Fed policymakers, after a two-day meeting that ended Wednesday, pointed to evidence that "economic activity is leveling out." But they also found that "economic activity is likely to remain weak for a time." As a result, they left short-term interest rates unchanged at almost zero and offered few hints of when -- or if -- other lending programs might be withdrawn.

It all reflects a new phase in the Fed's response to the recession. The days of announcing vast new programs almost weekly are long gone. But neither are top Fed officials eager to eliminate numerous lending programs. Rather, the central bank is in a period of carefully monitoring the incipient recovery and winding down programs only reluctantly, lest they prevent the recovery from taking hold.

"The Fed will be in wait-and-see mode for some time," said Paul Ashworth, senior U.S. economist at Capital Economics. "They want to see how the recovery begins to develop before they move on an exit strategy."

The central bank is trying to avoid the mistakes of Japanese officials in the 1990s, who repeatedly signaled that they would remove policies meant to support growth when there were only hints of economic improvement. That, in the view of many economists, prolonged the recession there.

Just yesterday, the policymaking Federal Open Market Committee said that the Fed "will employ all available tools" to promote a recovery and that it will leave its target for short-term interest rates "exceptionally low" for an "extended period." It left that rate in a range of zero to 0.25 percent, as was widely expected.

"They're saying that they're not even going to let us think that they're looking at raising interest rates until the economy has improved significantly further," said Alan Levenson, chief economist at T. Rowe Price.

When the Fed announced its plan to buy $300 billion in Treasury bonds in March, the economy was in virtual free-fall and the central bank was throwing all possible tools at stopping the decline. Although the program is small relative to other Fed actions, especially $1.45 trillion in mortgage-related securities the Fed is buying, it proved particularly controversial.

Some critics -- including lawmakers-- feared that the Fed would continue essentially printing money to pay for large budget deficits. With that bad public image, and mixed evidence on whether the program was succeeding at pushing down long-term interest rates and improving market functioning, the Federal Open Market Committee indicated Wednesday that it will "gradually slow the pace of these transactions" and complete the purchases by the end of October.

Leaders of the central bank want to keep their options open on when and how to wind down the remaining programs. While they noted in the statement accompanying their decision that "conditions in financial markets have improved further in recent weeks," they are all too aware that financial crises can come and go in unpredictable ways.

Thus they gave no new signals about the program to buy $1.45 trillion in mortgage-related securities, which is helping maintain low mortgage rates despite credit markets that continue to be strained.

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