Fed Swaps Bonds for Word Qualifiers

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What's the value of $10 billion of monthly bond purchases? Four carefully chosen words.

The Federal Reserve took the first tapering step today,announcing a reduction in its $85 billion of monthly asset purchases by $10 billion, evenly divided between Treasury and mortgage bonds, starting next month. At the same time, policy makers modified their forward guidance. Not only will the funds rate be exceptionally low "as long as" the unemployment rate remains above 6.5 percent, but it will stay there "well past that time," too. How long is "well past"? I don't know. They don't know, either. That's forward guidance for you.

Financial markets took the news in stride. After an initial skid, stocks surged and bonds rallied, though Treasuries have since retreated. Investors have had three months to get over their Bernanke-misled-us snit and adjust to the idea that quantitative easing is coming to an end.

I had thought the Fed would wait until next year to cut back. In retrospect, it gives the once-controversial bond-buying program a nice sense of closure with Fed Chairman Ben Bernanke taking the first step to unwind what began on his watch. Not that it will be ending anytime soon. Bernanke said continued cuts in asset purchases would be "data dependent," not on a "pre-set course." The process could take about a year, assuming continued improvement in the labor-market outlook and no further decline in inflation.

Perhaps the most disturbing modification to the Fed's economic projections is the continued reduction in estimates for potential growth. One year ago, policy makers thought that the economy had the ability to expand at a rate of 2.2 percent to 3 percent over the long run. In September, the range was 2.1 percent to 2.5 percent. It was pared again to 1.8 percent to 2.5 percenttoday. Potential output is a function of the growth in the labor force and in productivity. It's one thing to be concerned about the actual pace of growth, which has averaged 2.3 percent since the recession ended. It's another thing to conclude that future growth will be constrained.

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