It’s not yet a done deal, but it seems increasingly likely the Federal Reserve will begin scaling back its massive monthly bond purchases before long — perhaps in September.
But whether that is just the first step in a continuous process of policy firming, ultimately leading to rate hikes and balance sheet shrinkage, remains in doubt.
That’s because the economic recovery remains in doubt.
Minutes of the Fed’s June 18-19 Federal Open Market Committee (FOMC) meeting show divisions and uncertainties — with half saying “quantitative easing” should end late this year and others wanting the FOMC to await better jobs numbers and dial back bond buying more gradually, continuing it into next year.
The minutes don’t alter the fact, however, that there has been a considerable change in majority FOMC sentiment in recent months, culminating in the Committee’s June 19 determination that the economic outlook has brightened, that downside risks have “diminished” and that below-target inflation is likely to prove “transitory.”
Nor do the ostensible contradictions in the minutes change the fact that Fed Chairman Ben Bernanke, at the FOMC’s behest, conveyed the majority’s view that the Fed may well start tapering its $85 billion per month purchases of longer term Treasury and agency mortgage-backed securities “later this year” and perhaps end them by mid-2014, assuming the unemployment rate has fallen to about 7%.
Although various Fed officials subsequently tried to soothe financial markets after stocks plunged and bond yields soared, none really contradicted that basic message.
To be sure, the message was misinterpreted in some quarters. Bernanke was careful to say that any reduction of bond purchases would be contingent upon continued improvement in the labor market outlook. And he said “one of the preconditions for the policy path that I described is that inflation begin at least gradually to return toward our 2% objective.”
Bernanke stressed again and again that the Fed is not contemplating a tightening of monetary policy, only a reduction in the pace at which it is injecting stimulus in the form of additional bank reserves. Actual rate hikes are still far down the road — “a considerable interval” after the Fed stops buying assets, he said.
Despite all of Bernanke’s efforts to explain the FOMC’s monetary strategy, financial markets worldwide tanked, perhaps not surprisingly. Stocks and bonds plunged and still haven’t recovered. But most Fed officials, while not wanting to see persistent adverse market moves of the kind that could undermine the very economic projections upon which tapering would be predicated, recognize that sometimes central bankers have to let the chips fall where they may if they’re going to honor their commitment to adjust policy to changing economic conditions.
The Fed could not simply keep creating new reserves at a $1 trillion pace indefinitely in the face of improving labor markets and mounting risks that super-low interest rates eventually might undermine financial stability.