WASHINGTON — Is this week when the Federal Reserve finally slows its aggressive stimulus for the economy? Or does it want more evidence of a consistently improving economy?
It’s a close call. Yet most economists think the Fed will maintain the pace of its monthly bond purchases to keep long-term loan rates low to spur spending and growth.
The decision carries high stakes for individuals, businesses and global financial markets. A pullback in the Fed’s bond buying would likely send long-term rates up and stock and bond prices down.
Many analysts think the Fed will signal that it expects to slow the pace of its bond purchases from $85 billion a month, perhaps early next year, if the economy strengthens further.
The Fed will announce its decision after its latest policy meeting ends today, just before Chairman Ben Bernanke holds his final quarterly news conference. Bernanke will step down Jan. 31 after eight years as chairman.
That the Fed is even considering slowing its stimulus is testament to the economy’s improvement. Hiring has been robust for four months in a row. Unemployment is at a five-year low of 7 percent. Factory output is up. Consumers are spending more. Auto sales haven’t been this strong since the recession ended 4½ years ago.
What’s more, the stock market is near all-time highs. Inflation remains below the Fed’s target rate. And the House has passed a budget plan that seems likely to avert a government shutdown next year. The Senate is expected to follow suit.
“It really feels like the economy has finally hit escape velocity,” said Mark Zandi, a chief economist at Moody’s Analytics, citing a term Bernanke has used for an economy strong enough to propel growth and shrink unemployment without the Fed’s extraordinary help.
Still, only one-fourth of more than three dozen economists surveyed last week expect the Fed to scale back its bond purchases this week.
One complicating factor is the transition the Fed is undergoing as Bernanke enters his final weeks as chairman. Beginning in February, he will be succeeded by Janet Yellen, now the vice chairwoman. The Senate is expected to confirm her nomination as chairwoman this week.
The economists surveyed think Yellen will be more “dovish” than Bernanke – that is, more likely to stress the need to reduce still-high unemployment than to worry about inflation.
Investors have been on edge about a pullback in the Fed’s bond purchases since June, when Bernanke proposed a timetable for a slowdown. He said the Fed could start reducing its bond purchases before 2013 ends and stop the purchases altogether by mid-2014. His remarks threw markets into turmoil. The Dow Jones industrial average plunged. Interest rates spiked.
Markets have since recovered. The calmness among investors suggests that they’ve absorbed a point Bernanke has stressed repeatedly: That even after the Fed scales back bond purchases, it will still provide significant support for the economy.
In addition, the Fed plans to leave its key policy lever for short-term rates at a record low near zero, where it’s been since December 2008. It’s said it plans to leave its short-term rate ultra-low at least as long as unemployment remains above 6.5 percent and the outlook for inflation doesn’t top 2.5 percent.
An unemployment rate of 6.5 percent wouldn’t automatically trigger a rate increase, Bernanke has said. To stress that short-term rates will remain ultra-low, some Fed officials favor announcing an unemployment threshold of 6 percent before any rate increase would be considered.
One factor in the Fed’s hesitance to reduce its stimulus is that inflation remains historically low. The Fed’s optimal rate is 2 percent. For the 12 months ending in October, consumer inflation as measured by the Fed’s preferred index is just 0.7 percent, well below its target. The Fed is as concerned about under-shooting the inflation target as over-shooting it. Both are seen as threats to the economy.
Some economists think the Fed may decide to leave its policy unchanged in December just because Bernanke and other officials have sent no clear signal of their intentions.
“Reducing bond purchases is going to happen at some point, but I don’t think they have done enough explaining yet to prepare the markets for the move,” said Diane Swonk, chief economist at Mesirow Financial.
Once the Fed does slow its bond purchases, many economists think it will start by reducing its monthly pace by just $10 billion to $75 billion. But much will return on the collective decision-making of a policy committee with an evolving membership.
Besides Yellen’s ascension to the chairmanship, the White House will soon announce a new vice chair. In addition, two vacancies on the Fed’s seven-member board must be filled. And in January, four regional Fed bank presidents will gain votes on the committee, replacing four others.
In part because of such changes, some think the Fed might decide not to trim its bond purchases until March – the first meeting with Yellen in charge.
“I think they will wait until March when they have a new team in place,” said Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University.
He added, though, “I don’t see that it will make a whole lot of difference whether they do it in December or March in terms of the economic effects.”