Curious Capitalist

Tapering Is the Right Decision for Federal Reserve

Why the central bank's move makes sense now

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Gary Cameron / Reuters

The most important market shift in the past five years has begun. Contrary to expectations, the Fed announced on Wednesday that it would begin tapering its $85 billion-a-month asset-buying program, a money dump that most economists believe is one of the key reasons we’ve been in a five-year bull market. The “tapering” is a gentle one — the Fed will buy $35 billion a month rather than $40 billion a month of mortgage-backed securities come January, and $40 billion rather than $45 billion of long-term T-bills.

That’s as it should be. The Fed looks at three things when deciding whether the economy can stand on its own with less monetary stimulus: First, is unemployment coming down? Yes, to the lowest levels since 2009. Next, is growth back? The latest numbers, which show economic growth of 2.8%, are looking good. Finally, is inflation where it should be? That’s where things look dicier. As the Fed itself said in its announcement, inflation isn’t expected to hit the target rate of 2% for another year and a half. That indicates weak demand, which means that the recovery isn’t yet going full-steam ahead, and Ben Bernanke and the other Fed officials need to be careful about turning off the money spigots too quickly.

I think today’s announcement was a wise move for three reasons. One, there’s little doubt in my mind that the $4 trillion Fed balance sheet has created a sense of complacency in terms of holding risk — we already saw emerging-market and commodity bubbles burst back in the summer when the Fed first hinted that it was thinking of tapering. Better to let the gas out of the bubble slowly, as the Fed seems to be doing, than to have to move quickly and risk a disorderly exit from asset buying at a later date. Second, I believe the benefits of quantitative easing were largely tapped out (you can see this in the market reaction, which has lessened with each announcement of more stimulus, as well as the fact that the overall money flow in the real economy has remained flat). Finally, I think that it makes sense for Bernanke, the architect of QE, to end his tenure at the Fed by creating a clear pathway for his successor, vice chair Janet Yellen, whose key task when she takes on her new job will be to make sure that the end of the biggest unconventional monetary-policy program in history doesn’t rattle markets — or derail the recovery.