Ten billion dollars a month is a “modest” amount at the US Federal Reserve.
That was the reduction that the central bank announced in its monthly purchases of Treasury notes and other government-backed bonds, so-called quantitative easing that has pumped some $1.3 trillion into the markets since September 2012.
After months of hand-wringing debate, the start of the Fed’s tapering of its bond-buying represented a pivot away from unconventional monetary policy, and global stock markets rallied.
But the Fed will still be buying $75 billion a month in bonds, an extraordinary pipeline of cash meant to push investment out of the save haven of US treasuries and into the private, productive economy.
The central bank’s decisive moment fell just ahead of Monday’s centennial of the Federal Reserve Act. At the time of its creation on December 23, 1913, the United States was the only major economy without a central bank.
The Fed faces a leadership change, too, with Chairman Ben Bernanke after eight years at the helm to be succeeded on February 1 by his current deputy, Janet Yellen. Expected to receive Senate confirmation any day, she would be the 15th Federal Reserve chief and first chairwoman.
“Our modest reduction in the pace of asset purchases reflects the (Fed’s) belief that progress towards its economic objectives will be sustained,” Bernanke said after Wednesday’s policy announcement, in his last press conference as Chairman.
The ongoing quantitative easing is likely to be gradually pared down but “certainly not” ended before late 2014, he said.
Meanwhile, the Fed has kept its key interest rate for banks at an unprecedented near-zero since December 2008, with forward guidance that the rate will remain “exceptionally low” for “a considerable time” even after the now four-and-a-half year economic recovery strengthens.
Yellen will be steering the Fed out of these uncharted waters for years to come. The long-term impact of so much monetary stimulus is unpredictable.
Bernanke’s first suggestion in May of a looming taper set off a two-month stock market selloff. But Wall Street indices closed at record highs Wednesday, just two hours after the Fed announcement.
A side effect of quantitative easing has been investment gushing into fast-growing emerging and developing economies, which could well suffer painful reversal in capital flows as the Fed turns off the spigot.
Historically low mortgage rates, which have helped stabilise the shattered US housing market, could rise quickly as long-term interest rates respond to the reduction in Fed money.
In an address marking the upcoming centennial, Bernanke conceded that the Fed’s response since the 2008 financial crisis “was very new — it was unprecedented in both scale and scope.” But he defended the policies as “controversial but necessary measures” in the 21st century global economy.
Critics, though, have decried the loose monetary policy as punishing savings, risking inflation and pumping up new, dangerous investment bubbles.
“You cannot repress interest rates forever in a modern market without causing damage, and I think the Fed realizes that,” Mohamed El-Erian, chief executive of Pacific Investment Management Co (PIMCO), the world’s largest bond fund manager, told broadcaster CNBC.
Despite massive intervention, full employment and price stability — the “dual mandate” that Congress placed on the independent central bank — have yet to be restored. Inflation for the 12 months through November was 1.2 per cent, well below the Fed’s 2-per-cent target, with unemployment still at 7 per cent, a five-year low.