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Yearender: U.S. Fed starts QE3 tapering, experts advise caution

As the U.S. economy and job market are on firmer footing in recent months, the U.S. Federal Reserve finally announced it would wind down its massive bond purchases starting January, with experts urging the central bank to exercise caution and avoid hurting the ongoing economic recovery.

Modest QE3 Reduction

In what amounts to the beginning of the end of its bond-buying program, the Fed will "modestly" cut back on its monthly asset purchases from 85 billion U.S. dollars to 75 billion dollars, with 10 billion dollars trimmed equally from mortgage-back securities (MBS) and Treasury bonds, the central bank announced on Dec. 18 after a two-day policy meeting of its Federal Open Market Committee (FOMC), the Fed's powerful policy setting panel.

Since the onset of the financial crisis, the Fed has kept its short-term interest rate at historically low levels and completed two rounds of quantitative easing programs, known as QE1 and QE2. The Fed is now purchasing MBS at a pace of 40 billion dollars per month and longer-term Treasury securities at a pace of 45 billion dollars per month, commonly known as QE3.

U.S. stock markets have been buoyed by the QE3 tapering news, as the tapering has been launched smoothly and the Fed reaffirmed its commitment to continuing monetary easing "until the outlook for the labor market has improved substantially in a context of price stability."

The Fed also decided to keep the target range for the federal funds rate at zero to 0.25 percent. "To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens," according to the FOMC statement.

Upbeat Economic Data

The widely-scrutinized Fed's policy shift comes after a string of data pointed to better-than-expected economic growth pace and steady improvement in the labor market.

The U.S. unemployment rate in November declined to 7 percent, the lowest level in five years with job creation growing at a steady pace. The U.S. economy increased at an annual rate of 4.1 percent in the third quarter, mainly boosted by strong private inventories and personal consumption, the fastest pace of economic growth since the fourth quarter of 2011.

The FOMC sees the improvement in U.S. economic activity and labor market conditions since October "as consistent with growing underlying strength in the broader economy," said the Fed, adding that "household spending and business fixed investment advanced, while the recovery in the housing sector slowed somewhat in recent months. Fiscal policy is restraining economic growth, although the extent of restraint may be diminishing."

"Today's policy actions reflect the Committee's assessment that the economy is continuing to make progress, but that it also has much farther to travel before conditions can be judged normal," U.S. Fed Chairman Ben Bernanke said at a press conference after the FOMC meeting, possibly his final planned meeting with reporters.

The federal government was shut down for 16 days starting on Oct. 1, its first one in 17 years, and only reopened after Congress approved a short-term funding bill. A two-year budget plan crafted by bipartisan negotiators sailed through both chambers of Congress prior to Bernanke's press conference, eliminating the possibility of a government shutdown in the next two years.

"This tapering of asset purchases was prompted by increasing signs that economic activity is accelerating as the sizable fiscal drag on the economy in 2013 begins to wane. Moreover, the Fed's efforts to push down longer-term interest rates through its QE program have boosted interest-sensitive outlays, most notably housing and motor vehicles," said David Stockton, a senior fellow at the Washington-based think tank Peterson Institute for International Economics (PIIE).

"And the continued improvement of household balance sheets is providing consumers the wherewithal to increase their spending. The recent readings from the labor market have, moreover, been favorable, with gains in private payrolls averaging nearly 200,000 over the past three months and the unemployment rate falling to 7 percent," Stockton said in an analysis article.

Calls for Balancing Multiple Tasks

Some experts contended that the Fed's move to unwind its monetary stimulus was premature, as the U.S. economic recovery may experience twists and turns. Some analysts believed that the central bank should balance its multiple tasks of fostering economic growth, boosting job creation, keeping inflation in check and avoiding future financial crises.

"The Fed will need to exercise caution as it scales back further on its pace of asset purchases. We have experienced several episodes in the past few years when a burst of favorable data led to increased optimism that soon proved unwarranted," warned Stockton, former chief economist at the Fed.

"This small reduction in the pace of purchases of long-term bonds is not likely to derail the recovery. Indeed, I expect somewhat faster economic growth in 2014 than 2013 because spending cuts and tax increases at all levels of government will be much smaller next year," said Joseph Gagnon, a senior fellow at the PIIE.

With inflation notably below the 2-percent target and unemployment not expected to return to normal for three more years, it is too soon to back off from doing the utmost to sustain economic growth, said Gagnon, a former senior economist at the Fed.

Eric Rosengren, president of the Federal Reserve Bank of Boston, a dovish dissent, voted against the FOMC's latest modest tapering as a "premature" action.

The Fed's policy of aggressive, continuous monetary easing -- keeping short-term interest rates close to zero, announcing its intention not to raise them without strong signs of recovery, plus substantial ongoing purchases of Treasury and mortgage backed securities -- has contributed substantially to recovery from the Great Recession, said Alice Rivlin, a senior fellow at the Brookings Institution.

"Americans, quite rightly, have multiple objectives for the performance of their economy, including high employment, low inflation, and financial stability. The job of the Federal Reserve and other economic policy-makers is to balance those multiple objectives as effectively as they can," Rivlin, former vice chair of the Fed, told lawmakers earlier this month during a testimony at the House of Representatives.

[Source: Xinhua, Washington, 23Dec13]

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