Fed declares economy strong enough for bond-buying stimulus to end
In the dark days of the 2008 financial crisis, the Federal Reserve began buying tens of billions of dollars in bonds each month in a controversial, last-ditch effort to stimulate the economy.
Now, nearly six years and more than $4 trillion in purchases later, central bank policymakers declared Wednesday that the economy is strong enough for the Fed to end the unprecedented program.
In their statement following a two-day meeting, Fed officials gave their best assessment of the labor market in years, citing the “solid” job gains in recent months and the faster-than-expected drop in the unemployment rate, which fell to 5.9% in September.
“The numbers in the economy are good enough to justify it,” said Alice Rivlin, a former Fed vice chair and now a visiting professor at Georgetown University.
Still, amid worries about a slowing global economy, edginess in financial markets and still-weak housing activity, the Fed maintained its commitment to keep its benchmark interest rate near zero for a “considerable time” following the final $15-billion purchase of Treasury notes and mortgage securities this month.
The Fed’s key short-term interest rate has been at rock bottom since December 2008, and the focus in the markets now shifts to when Fed Chairwoman Janet L. Yellen and her colleagues might begin to raise it.
Most see that first rate hike coming in the middle of next year, but some analysts have pushed those expectations to later next year because of the uncertain growth prospects in major economies around the world.
The Eurozone has stagnated, Japan’s momentum has stumbled and China’s growth has slowed. That has weakened commodity prices and held down long-term interest rates, and it has left the U.S. as the primary engine of global growth. Economists expect the American economy to show a healthy expansion of about 3% in the second half of this year and next year.
The conclusion of the bond-buying, which had a relatively stronger effect on California, followed a carefully scripted plan by the Fed to give investors and markets plenty of time to prepare for the removal of the stimulus.
Stock markets took Wednesday’s news in stride. The Dow Jones industrial average seesawed after the midday Fed statement but ended down only 31 points, or less than 0.2%. Broader indexes fell similarly.
Most economists believe the stimulus initiative, known as quantitative easing, boosted the recovery from the Great Recession. Two-thirds of the respondents polled this summer by the National Assn. for Business Economics said the program has been a success.
The purchases helped resuscitate the housing market by pushing down mortgage rates to historic lows, a benefit especially in pricey housing markets such as the Bay Area and parts of Southern California.
The stimulus also fueled a stock market surge that fattened investor portfolios and aided U.S. exporters by lowering the value of the dollar, making their products cost less abroad.
All that happened without triggering the runaway inflation some critics had feared.
“I think it provided a transition period for the economy to get its wheels under it and move on,” said John Silvia, chief economist at Wells Fargo and president of the business economics group.
But it remained unclear how much the stimulus helped the economy — and if the effort was worth the costs.
Millions of seniors and others who depend on savings have seen the growth of their bank accounts stunted by low long-term interest rates. Income inequality has widened as stock prices have soared. And some fear the purchases have created a financial markets bubble destined to burst.
John Gross, a retiree in Bakersfield, called the Fed’s bond-buying and overall easy-money policies a disaster for savers like him.
The 70-year-old, who ran a loan business in San Diego, remembered that in 2006 when he and his wife moved to the Central Valley, they were earning 5.95% interest on their savings, not 1% as they have in recent years. For the Grosses, that has meant $2,700 less a month on which to live.
“We don’t take any more cruises,” he said. “When we go to the coast, we stay with friends. No more restaurants; we eat in.”
The Fed faces the challenging task of disposing of the assets on its bloated balance sheet — more than four times larger than when the bond-buying began — without damaging the economy or the central bank’s own finances.
“It’s hard to make a compelling case that it’s been a big success,” said John Makin, an expert on monetary policy at the American Enterprise Institute, a conservative-leaning think tank. “It’s an expedient that has outworn its usefulness, and it’s time to say goodbye.”
The Fed normally tries to stimulate the economy by lowering its benchmark interest rate, which reduces borrowing costs and creates an incentive for businesses and consumers to spend instead of save.
But with the economy in free-fall in November 2008 and the Fed’s interest rate approaching zero for the first time ever, it turned to large-scale bond purchases. The tactic had been used only once before, by Japan’s central bank in the early 2000s to help fight deflation.
“We were heading toward the brink, and this was something that basically helped us pull back from the edge,” said Beth Ann Bovino, chief U.S. economist at Standard & Poor’s Ratings Services.
The Fed has run the program off and on for much of the last six years. Twice before, in March 2010 and June 2011, Fed policymakers stopped it after purchasing a pre-set amount of assets — only to start again because the economy remained weak.
The most recent round began in September 2012 and was open-ended, with the Fed purchasing $45 billion in mortgage-backed securities and $40 billion in Treasury bonds a month until the outlook for the labor market improved “substantially.”
The unemployment rate was 8.1% at the time. It dropped more than a percentage point by last December, when the Fed announced it would slowly reduce its monthly purchases.
Mark Zandi, chief economist at Moody’s Analytics, estimated the program’s three rounds have reduced the price of 10-year Treasury bonds by 1 percentage point, to about 2.25%, which in turn has reduced mortgage rates and corporate borrowing costs.
Zandi said that without the stimulus, the stock market would be 10% lower and the housing market recovery would have been delayed by a year.
“It’s lifted the economy. It’s caused job creation,” he said. “The benefit of that swamps any negatives.”
Former Fed Chairman Ben S. Bernanke said in mid-2012 that central bank analysts had found the first two rounds of bond-buying might have added more than 2 million jobs to private payrolls.
But some economists dispute that, and most agree that the program had become less effective over time. The first two rounds, launched in the tough economic times of 2008 and 2010, provided a major psychological boost that the Fed was prepared to do as much as it could to stimulate growth.
The bond purchases contributed to the bull market, said Gary Schlossberg, senior economist at Wells Capital Management in San Francisco, “but it’s arguable how much that increase in wealth is driving consumer activity.… I go along with the view that its effect in boosting economic growth was limited.”
Even after the purchases end, the Fed plans to slowly reduce the amount of assets it is holding in hopes of maintaining some stimulus effect. Yellen said last month it could take until the end of the decade to get back to the amount of holdings the Fed had before the purchases began.
