Fed Continues Taper: No Surprise or Vote of Confidence for Economy?

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Coming as no surprise, the Federal Reserve tapered its monthly bond buying by a further $10 billion, dropping its monetary stimulus to $45 billion per month. This decrease represents the fourth consecutive $10 billion reduction and puts the the bond-buying program, which was conceived in the aftermath of the financial crisis and recession, on track to conclude as soon as October.

Recent economic data “indicates that growth in economic activity has picked up … after having slowed sharply during the winter in part because of adverse weather conditions,” the central bank said in a Wednesday statement released after a two-day policy meeting of the Federal Open Market Committee. While business investment has “edged down,” as the first quarter’s gross domestic product numbers show, consumer spending “appears to be rising more quickly,” the central bankers noted. More broadly, the Fed’s move to further decrease its monthly asset purchases is a vote of confidence in the U.S. economy.

The Fed’s gradual reduction of its extraordinary monetary stimulus program will soon end an initiative — designed to decrease borrowing costs in order to boost stronger consumer and business spending — that more than quadrupled the central bank’s balance sheet to $4.2 trillion. With the conclusion of the bond-buying program in sight, the Fed is preparing for a number of important policy decisions to bring its balance sheet back to fairly normal levels. More importantly, the decision will lift the benchmark short-term interest rate, or federal funds rate, from the near zero level maintained since late 2008.

Since December, the central bank has been winding down its extraordinary economic stimulus program. The effectiveness of the Federal Reserve’s highly accommodating monetary policy has diminished, and policymakers are well aware of that fact. The Fed began its asset purchases as a means to push down long-term borrowing rates in order to spur investing and hiring. But monetary stimulus had begun to service an unproductive addiction to easy money – for that reason, and because the economy was soldering through a slow but real recovery, the FOMC announced at the conclusion of its December meeting that it would reduce the flow rate of assets being purchased for quantitative easing.

While the recovery may be real, its slowness is remarkable. It has been nearly five years since the United States economy began expanding after the nearly two-year-long recession, but in many ways, the recovery is lopsided. The stock market rally of 2013 was record-breaking; home prices in many regions of the country are returning to pre-recession levels; and corporate profits hit new highs last year and accounted for 11.1 percent of the nation’s economic output. Many companies, though, are not putting back that cash into the economy by hiring new workers. With hiring trending below pre-recession levels, workers have little leverage to push for higher wages.

In the first quarter of 2014, growth of U.S. gross domestic product — arguably the most important indicator of the health of the country’s economy — slowed to just 0.1 percent, the weakest growth on record since the end of 2012. Some economists argued that while weak, the quarter should not provide cause for concern, as those economic components that drag on growth tend not to persist, while those that are strong are becoming trends. Consumers were big spenders in the first quarter, propping up growth as they have for much of the recovery. But other sectors of the U.S. economy that have buoyed the recovery in recent quarters slumped in the early months of this year, with much of the hurt brought on by the frigid winter weather.

While some argue that weak growth is the new normal, the Fed’s actions this week seem to say that weak growth does not necessarily mean the economy is not improving. “What the Fed is saying is ignore this first quarter number, it’s not reflective of the underlying strength in the economy,” Federated Investors chief equity market strategist Phil Orlando told Reuters.

The Federal Reserve predicted that the economy will expand at between a 2.8 percent and a 3 percent rate this year, with the unemployment rate falling to between 6.1 percent and 6.3 percent. After the release of the first quarter’s GDP figure, analysts now believe that even if growth picks up, 2014 economic growth is unlikely to surpass 3 percent, which is lower than the average 3.3 percent rate of growth experienced by the U.S. economy since 1929.

The second policy-setting meeting led by Chair Janet Yellen did not offer any guidance as to when the the target interest rate will be increased. As the Fed said has said before, the overnight target rate will be kept between zero and 0.25 percent “for a considerable time” after the bond-buying program ends, and that time frame was reiterated on Wednesday. In December 2012, policymakers announced that they would not consider raising the benchmark interest rate until the unemployment rate fell to 6.5 percent as long as inflation seemed likely to remain below 2.5 percent.

But Fed officials now believe the headline unemployment rate is too limited an indicator of the health of the labor market. The rate of joblessness has fallen to 6.7 percent in recent months, meaning it is extremely close to the Fed’s targeted rate. Yet Yellen thinks the labor market is still far too weak to increase rates. Declines in the unemployment rate have come in large part because many out-of-work Americans have become discouraged and stopped looking for work, which means they are not part of the labor force and no longer counted as unemployed.

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