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interest rates unchanged at almost zero and offered few hints of when -- or if -- other lending programs might be withdrawn.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.
Substantively, the purchase of mortgage securities should have a similar economic impact to the purchase of Treasury bonds: Both consist of printing money and expanding the Fed's balance sheet to drive down long-term interest rates. But the mortgage program is less of a lightning rod in Congress and the press in that it does not smack of the Fed financing government deficits.
Still, the planned gradual wind-down of Treasury purchases could offer a model for how the Fed, when the day comes, will end the purchase of mortgage securities.
"This action suggests the Fed may also slow the pace of its purchases" of mortgage securities as it approaches the end of the year, Dean Maki, chief U.S. economist at Barclays Capital, said in a report.
Another looming question is what to do with the Term Asset Backed Securities Loan Facility, or TALF, which is designed to support lending to consumers and businesses. It is scheduled to expire at the end of the year, and the Washington-based Fed Board of Governors -- not the FOMC, which also includes presidents of Fed banks around the country -- will have to decide whether to continue it.
Fed leaders view the program as successful in helping restart private credit markets, even though the volume of loans it has directly supported remains relatively modest. But it was enacted under an emergency lending authority, meaning that, legally, the Fed must end the program once it judges financial conditions to no longer be "unusual and exigent."
In further evidence of economic stabilization, the Commerce Department reported Wednesday that the trade deficit widened by less in June than was suggested in an early estimate of gross domestic product released last month.
The trade deficit rose to $27 billion in June from $26 billion in May, due mainly to higher prices for oil imports. But the number suggests that the decline in gross domestic product in the second quarter could be less than the 1 percent originally estimated.