The Federal Reserve’s trillion-dollar effort to shore up the U.S. economy is likely to come to an end in October, closing the books on a bold but controversial experiment that has tested the limits of the central bank’s power.
For the past year and a half, the Fed has been buying tens of billions of dollars in government bonds and securities each month in an attempt to tamp down long-term interest rates and boost the recovery. It was the third and largest bond-buying program the central bank has launched since the 2008 financial crisis. But officials have been slowly scaling back the effort this year, and documents released Wednesday show that the Fed’s policy-setting committee is nearly ready to call it quits.
“If the economy progresses about as the Committee expects . . . the final reduction would occur following the October meeting,” minutes of the central bank’s June gathering show.
The bond-buying programs, also known as quantitative easing, have been credited with pushing mortgage rates to historic lows, breathing life into the moribund housing market and fueling a boom in refinancing. But the rebound in real estate slowed as rates moved back up, leading to criticism that the Fed was unable to achieve a sustainable recovery.
The bond purchases have also helped send stock markets to record highs, with the Dow Jones industrial average crossing 17,000 last week. The index has hit a new high 14 times this year. But skeptics worry that the Fed could be setting the stage for another financial bubble, and others blame central bank policy for the country’s widening inequality.
“It kept a sense of calm” during the crisis “and it supplied a healthy dose to the real estate machinery,” said Alan MacEachin, corporate economist at Navy Federal Credit Union. But he added: “It’s a double-edged sword. The economy became addicted to it. It became reliant on it, to the point where it became very tricky for the Fed to end this program.”
Yet the finale for quantitative easing is only the first step in the Fed’s journey back to more traditional monetary policy. The central bank’s balance sheet has ballooned from about $870 million before the recession to $4.4 trillion. It has kept short-term interest rates near zero for six years, and investors are warily awaiting any sign that the Fed might raise them. The minutes of the Fed’s June meeting give little hint of when that would occur.
But they do show that officials are beginning to reach consensus on at least some of their next steps. One key question the Fed faces is when to allow the balance sheet to shrink by ending its current practice of reinvesting securities as they mature.
New York Fed President William Dudley recently argued that stopping the reinvestments could lead investors to believe an increase in interest rates is imminent. He suggested waiting until after the first interest rate increase to end the reinvestments to reduce any confusion — and a majority of Fed officials agree with him, according to the minutes.
“An earlier change to the reinvestment policy would involve risks to the economic outlook if it was seen as suggesting that the Committee was likely to tighten policy more rapidly than currently anticipated,” the documents read. “Moreover, an early change could add complexity to the Committee’s communications at a time when it would be clearer to signal changes in policy through interest rates alone.”
Officials also discussed new tools that the Fed could use to control interest rates. Historically, the Fed has relied on setting a target for the interest rate at which banks lend to one another overnight, also known as the federal funds rate. But the minutes show that most officials agreed that the interest rate paid to banks on the excess reserves they hold at the Fed will play a key role as the central bank tightens policy. Raising the rate that banks receive from the Fed would, in turn, increase the rate that banks must pay to borrow from one another.
The Fed might also use overnight reverse repurchase agreements — in which Fed sells securities to a financial institution and agrees to buy them back the next day — to help set a floor for interest rates. While the interest on reserves can only be paid to banks, the Fed can engage in so-called reverse repos with many kinds of financial institutions.