Lesson learnt, Fed plans to stick with stimulus policies
When the Fed's policymaking committee meets on Tuesday and Wednesday, its members are likely to spend a lot of time talking about the potential costs of the stimulus campaign. Then the Fed's chairman, Ben Bernanke, will probably seek to reassure investors that the Fed plans to press on.
The central bank is buying $US85 billion a month of Treasury and mortgage-backed securities because it wants unemployment to fall more quickly.
While recent data suggests growth is quickening, Mr Bernanke has said the situation remains unacceptable.
Mr Bernanke and the Fed vice-chairwoman, Janet Yellen, "have been abundantly clear in recent commentary that the improvement in the labour market to date falls far short of what they will need to see before reducing monetary policy accommodation," said Joseph LaVorgna, chief US economist at Deutsche Bank, in a client note.
Also, the federal government has just embarked on a new round of spending cuts, known as sequestration, and the extent of the resulting drag on the economy might not be evident for several months.
"The Fed will not take overt steps to scale back its asset purchases any time soon," said Lou Crandall, chief economist at Wrightson ICAP, a financial research firm. "The Fed is not going to take any chances until it is sure that we have avoided another spring/summer swoon."
The central bank has said that it plans to hold short-term interest rates near zero at least as long as the unemployment rate remains above 6.5 per cent. It was 7.7 per cent in February. The asset purchases are intended to hasten the arrival of that moment by further reducing long-term borrowing costs for businesses and consumers.
But Fed officials who disagree with the policy are increasingly vocal in their criticisms, which can dilute the impact of the Fed's efforts by causing investors to doubt how much longer rates will stay low. In response, Mr Bernanke and other supporters of the policies have tried in recent weeks to persuade markets that the purchases will continue because the benefits far outweigh the potential costs.
Frequently Asked Questions about this Article…
The Fed is buying about US$85 billion a month of Treasury and mortgage‑backed securities and keeping short‑term interest rates near zero. These asset purchases are intended to lower long‑term borrowing costs for businesses and consumers and help bring unemployment down faster.
Fed officials say past pauses in stimulus were premature and slowed the recovery, so they prefer to press on. Chair Ben Bernanke and other supporters believe continued purchases are needed because labour‑market improvement so far falls short of what is required to reduce policy accommodation.
The Fed has said it will hold short‑term interest rates near zero at least as long as the unemployment rate remains above 6.5%. The article notes the unemployment rate was 7.7% in February, so the Fed’s guidance suggests rates would stay low until the labour market improves significantly.
According to the article, the Fed is unlikely to take overt steps to reduce asset purchases soon. Economists quoted said the Fed won’t take chances until it is confident the economy has avoided another downturn, and Fed leaders have been trying to reassure markets the purchases will continue.
The article says Fed officials discuss potential costs of large asset purchases, and dissenting officials have become more vocal. That criticism can dilute the program’s impact by making investors doubt how long low rates will last, which could weaken the stimulus effect.
The federal government has started a new round of spending cuts known as sequestration, and the resulting drag on the economy may not show up for several months. That uncertainty makes the Fed more cautious about withdrawing support until the full effects are clear.
Investors should expect Fed officials to spend time debating the costs of the stimulus but also for Chairman Ben Bernanke to reassure markets that the Fed plans to continue its asset purchases. The message is likely to emphasise ongoing support until the labour market improves.
When Fed officials publicly disagree, it can cause investors to doubt how long low rates and asset purchases will continue. That doubt can reduce the effectiveness of the Fed’s actions and may increase market volatility as participants reassess interest‑rate and credit expectations.
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