Bernanke Bites the Economic Bullet and Begins QE3 Tapering

The US Federal Reserve has announced that it will begin to reduce its stimulus for the US economy, citing the job market, which has shown steady improvement. The Fed policy change could lead to higher long-term borrowing rates for individuals and businesses. The Fed is reducing its monthly quantitative easing (QE3) bond purchases from $85 billion a month to $75 billion starting in January. In its statement, the Fed says it will reduce its purchases of mortgage-bonds and Treasury bonds each by $5 billion. Beginning in January, it will buy $35 billion in mortgage bonds each month and $40 billion in Treasurys. The goal continues to be to hold long-term interest rates low to stimulate borrowing and spending. At his final news conference today, Chairman Ben Bernanke, who is retiring as Federal Reserve chairman in January, said the Fed expects to make "similar moderate" reductions in its monthly bond purchases throughout 2014 if economic improvements continue. At the same time, the Fed restated its commitment to record-low short-term interest rates. It said it plans to hold its key short-term rate near zero "well past" the time when unemployment falls below 6.5%. Unemployment is now 7%, still high by normal US standards but the lowest it has been in 5 years. The Fed's bond purchases were meant to drive down the price of bonds by increasing demand for them. The idea has been to induce people and businesses to borrow, spend and accelerate economic growth. A lower pace of purchases could mean higher rates, although the $10 billion reduction announced today is very small as a percentage of the continuing QE3 stimulus program. Nevertheless, investors were pleased with the Fed's finding that the economy has steadily strengthened, by its firm commitment to low short-term rates and by the slight amount by which it is cutting back on its bond purchases. The tapering had been expected to drive stock markets down, but the minimal tapering combined with the Fed's positive economic forecast for the US caused the Dow Jones to close at a new all-time high, up almost 300 points, or 1.8%. Bond prices also rose and the yield on the 10-year Treasury note dipped from 2.88 percent to 2.84 percent. Bernanke said that the Fed's new economic forecasts predict thzt unemployment will fall more over the next two years than it thought in September -- to 6.3% in 2014 and 5.8% in 2015. The Fed's preferred inflation measure won't reach its target of 2% until the end of 2015 at the earliest, according to Bernanke. The Fed worries about too low inflation because it can lead both individuals and businesses to delay purchases. Extremely low inflation also makes it cost more to repay loans. The Fed vote to begin tapering of QE3 was 9-1. Only Eric Rosengren, president of the Federal Reserve Bank of Boston, disagreed. He called the move premature because unemployment remains high and inflation extremely low. But, the new Fed forecasts say that hiring has been robust for four straight months, unemployment is at a five-year low of 7%, factory output is up, consumers are spending more at retailers and auto sales haven't been better since the recession ended 4½ years ago. Furthermore, the stock market has been near all-time highs. And the House has passed a budget plan that seems likely to avert another government shutdown next year. The Senate followed suit this evening. The biggest worry for Fed members is inflation, which remains historically low. The Fed's optimal rate is 2%. For the 12 months ending in October, consumer inflation as measured by the Fed's preferred index is just 0.7%, well below its target. But the Fed sees inflation slowly moving toward its target, based on its new economic foracasts. The Fed projects inflation would range between 1.4% and 1.6% in 2014 and could reach the Fed's target in 2015 at the earliest. Fed officials still project economic growth of roughly 3% next year. ~~~~~ Dear readers, the long march out of the Great Recession has begun in earnest. While the US recession ended 4 1/2 years ago, the recovery has been sluggish, with unemployment stubbornly staying above 7%. In his last act as Fed chairman, Ben Bernanke has chosen the rather bold move of announcing the beginning of the end of QE3. The Wall Street common wisdom had been that a tapering announcement would drive stock markets down hard and fast. But Bernanke outfoxed the pundits. His very cautious, slow tapering decision, based on a continuing fall in unemployment and an economic forecast predicting that the US recovery is gaining in strength and velocity, reassured the stock markets. The markets chose to play the recovery card and took off at Bernanke's announcement. As Fed chairman, Ben Bernanke has been accused of being too timid in 2005-2007 when the various bubbles were preparing to burst into the Great Recession. Today, Bernanke took his usual measured step toward removing the markets from his Federal Reserve life support. Time will tell if his decision and timing were right. If they were, his crisis management from 2008 to 2013 will be hailed as groundbreaking economic management that saved America and the world from a catastrophic depression. But as Bernanke said today, the US economy is still weak and QE3 will continue for as long as it is needed to keep the recovery on track. Because if he withdrew life support too soon, the recovery will stall and die. Bernanke's final reputation will not be known for sometime.