Published August 24, 2013
JACKSON HOLE, WY – Federal Reserve officials ended an annual conference Saturday on track to begin scaling back one of their major economic stimulus programs but remained divided over the timing of the changes.
New research presented at the conference, sponsored by the Federal Reserve Bank of Kansas City, and Friday's weak new home sales data served to muddy the outlook.
Conference debate centered on when the Fed should start cutting back its massive purchases of bonds, known as "quantitative easing" or "QE." It's currently buying $85 billion a month in bonds to try to keep interest rates low on mortgages, business loans and other credit. It has bought nearly $3 trillion in bonds since the financial crisis began in 2008.
In June, with signs the economic recovery was gaining strength, the Fed said it would begin tapering its bond purchases later this year--and end them altogether next year--as long as the economy continued to grow as it projected, especially in job creation and a lower unemployment rate.
At the conference, some Fed members said economic growth may be strong enough now to start trimming sooner rather than later, while others prefer to wait until indicators leave little doubt the recovery is on more solid, sustainable ground.
Some conference participants said that while earlier rounds of bond purchases may have helped the economy and the financial system, QE is now of limited benefit or ineffective. They worry extended QE could begin destabilizing financial markets and sow the seeds of high inflation.
A research paper presented at the conference reported that Fed purchases of Treasury bonds helped to lower borrowing costs for the federal government but did not do much to lower interest rates for businesses. However, researchers found Fed purchases of bonds backed by mortgages helped reduce rates on home loans "substantially."
The Fed's current purchases are split about evenly between the two types of bonds. The findings could help shape its plans for QE, some conference attendees said.
The Fed's deliberations over how to exit QE have roiled financial markets, sending interest rates higher and, more recently, stock prices lower. Since May, mortgage rates alone have jumped by about 1%, to about 4.5% for a traditional fixed-rate loan--though that is still low by historical standards.
Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said in an interview with FOX Business that he would not rule out a decision to start tapering at the Fed's next meeting of its policy setting body, the Federal Open Market Committee, in September, "but it could be later."
"The outlook that I have in mind is that the economy will improve a little bit in the second half, will continue on this sort of moderate growth path, the inflation numbers will begin to edge toward our (stated) target of 2% and move up gradually, unemployment will come down, the jobs picture will continue to produce net jobs of 175,000 to 200,000 per month--if that out look holds, then I think we can consider beginning to wean the economy from quantitative easing," he said.
He declined to comment on how much to taper, but said it should be a "cautious first step."
James Bullard, president of the St. Louis Fed bank, told FBN he felt the Fed did not "need to...be in any hurry to do the tapering," especially with inflation running below the Fed's 2% target.
"So I think we can afford to wait, get more data, see if the economy is strengthening the way we're predicting it will in the second half of the year," he said. The Fed will hold additional policy meetings in October and December.
A few days before its September meeting, the Labor Department will release its monthly jobs report for August. Former Fed governor Randall Kroszner, an economist at the University of Chicago, said the report could prove decisive.
"My guess is that if it's north of 200,000 [new jobs]--a strong report--plus [there are] some positive revisions to the previous months, then that's possibly going to push a few people on the edge [at the FOMC] to do it," he said about tapering. "If it's less than 150,000 and there are some negative revisions to the previous months, probably some people will step back. But the nightmare scenario is that it's probably somewhere in the middle--which is probably the most likely outcome--and will cause some more consternation, both for the FOMC members and the markets."
Kroszner said that with a stronger jobs report, the Fed could cut bond purchases by $20 billion a month, "plus or minus $5 billion" depending on other data and factors.
"I think they'd like to make it a substantive step down because I think one of the reasons they want to do this now is to be able to test the waters, see what the implications are for the economy, for the markets," he said.
Another former Fed governor attending the conference, Larry Lindsey, said investors should be prepared for more volatility as the Fed works to find the best path to ending QE.
"Let's face it, exiting from QE...is going to be a difficult job--that's something that maybe they should have thought about last December" when Fed members approved $85 billion in monthly bond purchases, he said. "But it’s gotta happen sometime. All you’re really doing with monetary ease or with fiscal ease is borrowing from the future. And we’ve been doing that for five years...You’ve got a little bit of a problem. And that’s what we’re facing."
Fed officials again stressed that dialing down QE does not mean they will start tinkering with their other major, separate stimulus tool: keeping short-term interest rates low and promising to keep them low for an "extended period," likely about two years or so. That especially helps keep short-term business lending cheap; QE was designed to put downward pressure on longer-term rates, especially 30-year fixed-rate mortgages.
In recent policy statements, the Fed has also left open the possibility that it could increase monthly bond buying, to add more stimulus for the economy, should the recovery falter.
Other Fed officials in Jackson Hole declined to comment on policy. But minutes of the FOMC's most recent meeting in July, showed little dissent on its plan to start tapering later this year contingent on stronger economic data.
The minutes also said "several participants" were interested in possibly strengthening the Fed's commitment to keep short-term interest rates low "if additional accommodation were to become necessary or if the (FOMC) wanted to adjust the mix of policy tools used to provide the appropriate level of accommodation" -- some "insurance" should winding down QE prove painful.
Officials may have gotten a taste of that Friday, when the Census Department reported sales of new homes plunged 13.4% in July, a hint that higher mortgages may be starting to cut into demand for homes. Analysts were projecting an annual new home sales rate of 487,000 units, but they came in at a pace of 394,000, from 497,000 in June.
--Sylvia Hall contributed to this article