The Federal Reserve announced a big change in policy on Wednesday that marks the latest stage in a long-running economic experiment. The Fed has been keeping the economic recovery afloat for years and the success or failure of the change the bank just announced will have major implications for America’s economy next year. Here’s what you need to know about how the change affects the country’s ongoing efforts to dig out from the Great Recession.
What The Federal Reserve Did Yesterday The central bank announced Wednesday that in January it will start shrinking the massive economic stimulus program it began in 2008. Under that effort, dubbed “quantitative easing” or QE in finance industry jargon, the Fed has been buying tens of billions of dollars worth of bonds each month as a way of juicing the economy. The bank also said that it will keep interest rates near zero for longer than it had previously projected, a move that emphasizes the gradual pace of the overall policy shift. The big news is the taper, however. Instead of buying $85 billion worth of bonds, as it’s been doing each month, it will buy just $75 billion worth in January. That slight reduction still signals that the bank will continue to buy large amounts of bonds throughout the coming year.
The point of the bond buying is to inject money into the economy, encouraging both businesses and consumers to spend, which in turn helps create economic growth and jobs. Its interactions with working people’s lives are indirect and hard to see, but the bond buying has played a critical role in supporting everyone’s economic well-being.
QE can’t go on forever without eventually causing serious inflation that could counteract all the positive impacts of the policy. While critics of the program have cried wolf about inflation for years and been proven wrong repeatedly, Wednesday’s announcement signals that the Fed is ready to start pulling back on the program. The trick is to get the timing right. Moving too soon could push the economy back into recession, but so could waiting too long.
How The Decision Will Impact The Markets The policy’s impacts are most visible and obvious in financial markets, and the central bank is moving cautiously so as not to spook investors. The reason everyone has been referring to this reduction in QE as “the taper” is that the Fed is trying to move gradually, and the form the taper is taking suggests the bank wishes it could do more. It isn’t slashing its bond buying drastically, but rather reducing it by $10 billion (or about 12 percent). The changed outlook on interest rates — it will keep them where they are well past the previously announced trigger point of a 6.5 percent unemployment rate — is a further effort to quell concerns about the pace of the taper. (Interest rates are the bank’s standard tool for managing the flow of money through the economy, but as ThinkProgress’ Jeff Spross has explained, those rates are already at their lowest possible level, which led the Fed to experiment with QE as a way of further juicing the supply of cash in hopes of boosting growth.)
The Fed’s caution appeared to pay off yesterday as markets rose on the news of the taper. Bond markets had been expected to react to the taper in ways that would raise interest rates for consumer credit, making life more expensive by raising rates for mortgages, car loans, credit cards, and the like. That didn’t happen on Wednesday, offering another sign that the Fed’s gradualism is being rewarded.
How It Will Impact Economic Growth And Jobs Without QE, the trillions of dollars in austerity measures enacted since the 2010 Tea Party wave would have likely pushed the economy into a second recession in 2014. The Fed thinks that the economy is now strong enough to weather the gradual contraction of the bond buying stimulus program.
It could be wrong. The evidence for a strengthening economy — solid monthly job growth and improving overall economic activity, plus a budget deal that eases the harmful cuts known as sequestration — is somewhat soft. The most recent jobs report was strong, but it wasn’t a major liftoff point compared to the past few years of monthly employment figures. The construction industry is feeling more optimistic than it has since 2005 and retail sales rose faster than expected in November, but these too are good signs but not huge upticks in business or consumer activity. If all of this proves to be fleeting phenomena rather than genuine signs of an increase in the rate of the economic recovery — if job growth and consumer spending sag again after the holidays — then the taper could prove premature and undermine the economy substantially, leading to job losses and other forms of economic pain for people far from the bond markets. The same positive cycle of borrowing, spending, and hiring that QE has helped to promote in recent years would be flipped upside down, reversing the gradual progress that’s been made at lowering unemployment and potentially causing every consumer credit transaction to get more expensive in much the same way as other recent economic doomsday scenarios.
If such a slump comes to pass in the new year, it could cause the Fed to change its mind about the taper. That could send the stock markets into a panic, hurting retirement savings and investment holdings for millions. But if the pace and timing of the taper announced Wednesday prove appropriate, working people probably won’t be able to see the policy working.