Fed Will Not Reduce Stimulus, Waiting for “More Evidence” of Recovery

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In one of the most anticipated announcements in months, the Federal Reserve’s Federal Open Market Committee declared that it would maintain its policy of buying $85 billion in government debt and mortgage backed securities per month, despite expectations that it would begin to taper these purchases in response to an improving economy.

According to a statement from the Fed, “the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.”

Markets reacted positively to the news, with the S&P 500 and Dow Jones Industrial indices surging to fresh highs. Following comments made by Fed Chair Ben Bernanke this year, many market participants expected that the Federal Reserve to begin pulling back its asset purchases by roughly $10 billion per month.

But in the Fed’s official statement and subsequent press conference, Bernanke stressed that the central bank’s decisions on monetary policy would be based on economic conditions on the ground rather than any previous guidance given by the bank.

Bernanke continued to be critical of recent budget cuts enacted by Congress as well as what looks to be a looming government shutdown and breach of the debt ceiling. Bernanke argued that recent budget cuts reduced growth in 2013 by as much as 1% and led to “hundreds of thousands” of fewer jobs being created. “A government shutdown or even failure to raise the debt limit will have very severe consequences for the economy,” Bernanke added. Asked about what the Fed can do blunt the effects of a government shutdown or failure to raise the debt ceiling, the Fed Chair said that the central banks tools “are very limited.”

Bernanke also addressed the issue of the reliability of the official unemployment rate as an indicator for the health of the labor market. Though the unemployment rate has declined from 7.9% to 7.3% this year, the overall level of employment has remained flat because many people have dropped out of the labor force. Bernanke argued that much of this declining labor force participation is part of an ongoing trend that is driven mostly by an aging workforce, and that “Most of the decline in the unemployment rate is due to job creation rather than lower participation.”

At the same time, Bernanke emphasized that the unemployment rate was not the only figure the Fed would use to evaluate the strength of the job market, and that it would pay attention to figures like the participation rate and broader measures of unemployment like the employment-population ratio when deciding the extent of its stimulus efforts going forward.

The Federal Reserve will have two more opportunities this year, during meetings in October and December, to fine-tune its monetary policy and it may announce a tapering of its quantitative easing policy at that time.