Ben Bernanke had one final surprise to spring on the markets before ending his tenure as chairman of the Federal Reserve. Bernanke and the other members of the Federal Open Market Committee announced on Wednesday that they would start pulling back on their massive monetary stimulus program, reducing the pace of monthly bond purchases from $85 billion to $75 billion starting in January.
“This is a toe in the tapering water, the absolute minimum reduction the Fed could announce without looking timid,” economist Ian Shepherdson of Pantheon Macroeconomics wrote in a note to clients following the announcement. “Still, it is the first step away from incremental easing since July 2006, so it is significant.”
Fed officials had signaled since May that they were looking to wind down their bond-buying, which has ballooned the bank’s balance sheet to $4 trillion as of this month in an effort to boost economic activity and asset prices. Many economists and Fed watchers had thought that, while it was possible that the Fed would announce its so-called tapering of asset purchases this month, it was more likely to wait until 2014.
The FOMC said it was confident enough to reduce the pace of purchases because it sees signs of “growing underlying strength” in the economy. It also said it would “likely reduce the pace of asset purchases in further measured steps at future meetings” if the labor market continues to improve and inflation climbs toward the Fed’s long-run target of 2 percent.
However, to forestall a market over-reaction, policymakers also signaled that they intend to keep interest rates near zero “well past” the point when unemployment declines to 6.5 percent. In previous statements, attaining the 6.5 percent unemployment level had been used as a potential condition for raising rates.
“The Fed didn’t want to reduce the overall level of stimulus that it is providing to the economy,” IHS Global Insight economist Paul Edelstein wrote in a report to clients. “It simply wanted to exchange a stronger commitment to low interest rates for less bond buying.”
Stocks rallied sharply on the Fed's vote of confidence in the economy, with the Dow Jones industrial average and the S&P 500 both ending the day at record highs.
In a release issued at 2 p.m., the FOMC said that it was seeing improvement in numerous economic benchmarks, including household spending, business fixed investment and, in particular, the job market.
In his press conference following the FOMC announcement, Bernanke said that while recovery “is far from complete,” since the central bank’s policy of quantitative easing began, the economy has added 2.9 million jobs and unemployment has fallen by more than a full percentage point.
“In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases,” the committee said in its statement. The bank will reduce its monthly purchases of Treasuries and mortgage-backed securities by $5 billion each.
However, Bernanke repeatedly cautioned that all future decisions about tapering the stimulus will be “data-driven” and that a change in economic conditions could drive a decision to either reverse the tapering or to cut stimulus even more quickly.
Fiscal policies set in Washington, the FOMC statement noted, continue to be a drag on recovery, but their impact may be receding. One possible factor in that assessment is the bipartisan budget agreement that passed the House of Representatives last week and is set to come before the Senate for a final vote this afternoon. That two-year budget eases $63 billion in spending cuts over two years as it unwinds some of the automatic across the board cuts known as “sequestration.”
“People don’t appreciate how tight fiscal policy has been,” Bernanke said at a press conference following the FOMC announcement. At this point in the preceding recession, which was not nearly as severe as the downturn the economy is now recovering from, governments at the local, state and federal levels had added 400,000 jobs. By contrast, in this recovery, governments at all levels have shed 600,000 jobs.
“That’s a million workers difference in people employed at all levels of government,” Bernanke said.
Today’s press conference was likely Bernanke’s last as Fed Chair. His successor, Janet Yellen, is expected to be approved by the Senate this week.
Asked whether the markets could expect a continuation of the tapering policy under a Yellen chairmanship, Bernanke said the answer was, unequivocally, yes.
“I have always consulted closely with Janet,” he said. He consulted with her closely in advance of the current decision, he said. “She fully supports what we did today.”
Of the ten members of the FOMC voting today, nine supported the decision to taper. Eric S. Rosengren, president of the Federal Reserve Bank of Boston, was the lone holdout. Rosengren argued that “until incoming data more clearly indicate that economic growth is likely to be sustained above its potential rate.”
This article was updated at 4:35 p.m.
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