It’s finally happened.
The Federal Reserve announced Wednesday that its bond-buying program, popularly known as quantitative easing, would be reduced from buying $85 billion a month to $75 billion a month. The Federal Open Market Committee, which sets monetary policy, said that it would reduce the program, designed to bring down interest and mortgage rates and stimulate the economy, due to “cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions.” Today’s announcement follows the most recent jobs figures, which showed 203,000 new jobs created in November and the unemployment rate at 7%.
But the Fed’s overall take on the economy was still somewhat gloomy. “The unemployment rate has declined but remains elevated,” it said in the statement. “The unemployment rate has declined but remains elevated. Household spending and business fixed investment advanced, while the recovery in the housing sector slowed somewhat in recent months.” The program started last September thanks to the still sluggish economy and weak job market.
The Fed had been buying $40 billion worth of bonds backed by mortgages issued by Fannie Mae and Freddie Mac and $45 billion worth of bonds issued by the Treasury.
The Fed expects the reduced bond-buying to continue to stimulate the economy. “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,” the statement said.
The bond-buying is not the only tool the Fed is using to strengthen the economy. Today’s announcement also slightly changed its interest rate policy. Previously the Fed has said that it will keep the rate it controls, the federal funds rate, at just above zero at least as long as unemployment is above 6.5% or until expected inflation gets above 2.5%. Today, the Fed said that “it likely will be appropriate to maintain” the federal funds rate “well past the time that the unemployment rate declines” below the 6.5% target if inflation remains below 2%. Inflation hasn’t been over 2% since early last year.
The market reaction to the news, which many expected to come in January or March, was a little all over the place. The S&P 500 immediately dropped just over 6%, but is now up 4% from its level right before the Fed’s decision came out.
In a press conference following the statement, Federal Reserve chair Ben Bernanke argued that, overall, the Fed’s new policy wouldn’t amount to less stimulus, “We’re not doing less,” he said “we’re providing a great deal of accommodation to the economy.” In both the statement and in his public remarks, Bernanke emphasized how tighter fiscal policy, both higher taxes and less spending, have lead to slower growth and higher unemployment, “In retrospect, it’s not shocking that the recovery has been somewhat tepid.”
Bernanke will leave the Fed at the end of January. Janet Yellen, the current vice chair, has been nominated to take the job is widely expected to be confirmed.