As I’m sure you’ve all heard, the Fed has decided to cut back on its monthly bond purchases. In the committee’s first unanimous decision since 2011, it has decided to scale down to $65 billion in Treasury and mortgage-backed securities holdings, from $75 billion in January and $85 billion every month last year. It also stated that it is likely to continue cutting down, so we are likely to see the same kind of cut-back in March (likely by another $10 billion). It also confirmed that it intends to hold benchmark short-term interest rates around zero, even after unemployment is below 6.5% (it was 6.7% in December). Many criticize the Fed’s decision, and point to the reaction of the stock market. However, being such a new strategy (or at least to this scale) put into place, the Fed has reason to be cautious.
Its decision is justified briefly in the press release:
“Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to make a further measured reduction in the pace of its asset purchases.”
In terms of continued stimulus, it states:
“The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.”
There seems to be much positivity in their statement, stating that growth picked up in recent quarters. The president of the Federal Reserve Bank of Dallas, Richard Fisher, says he noticed “a better mood than ever” after speaking with business executives, who also claim the fourth quarter was fairly good – better than people expected. There seems to be a positive outlook on recent growth, as well as future growth. On Thursday we will know exactly what that growth looked like, when the fourth quarter reports are released.
As for the stock market: yes, stocks sank in reaction to the news. Yahoo! Inc. fell by 8.7% (the most since July 2009), while Boeing Co. dropped 5.3% (its worst drop in over two years). The Standard & Poor 500 Index lost 1% and the Dow Jones Industrial Average fell by 1.2%. However, the Fed has real reasons to cut back. Should it continue to stimulate the economy at this scale for too long, the consequences of its asset-buying program may result in an asset-market bubble. Destabilizing financial markets in this way could have devastating results.
I agree that they are taking the cautious route, but rightly so. Should the Fed get over-confident about its stimulus-capabilities, the US (and the world) would be in bigger trouble. Quantitative easing hasn’t exactly been around for as long as we’ve had economic models – not at all. And although the strategy isn’t new, it is certainly the first time the Fed has applied it at such a large scale. This being so, I think the Fed has done an excellent job as it is and we will be glad not to see the possible consequences of over-confidence (effects which we may not even be aware of now).