Fed Sticks to Stimulus, Worried About Growth Soft Spots

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Chairman of the Federal Reserve Ben Bernanke testifies before the House Financial Services Committee on Capitol Hill in Washington, Wednesday, July 17, 2013. (AP Photo/Charles Dharapak)
Charles Dharapak/APFederal Reserve Chairman Ben Bernanke
By Pedro da Costa
and Alister Bull


WASHINGTON -- The U.S. Federal Reserve said Wednesday that it would continue buying bonds at an $85 billion monthly pace for now, expressing concerns that a sharp rise in borrowing costs in recent months could weigh on the economy.

The decision surprised financial markets that were braced for a reduction in the central bank's economic stimulus.

Citing strains in the economy from tight fiscal policy and higher mortgage rates, the Fed decided against a tapering of asset purchases that investors had all but priced into stock and bond markets.

"The tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market," the U.S. central bank said in a statement explaining its decision.

Stocks rallied on the Fed statement, with the S&P 500 (^GSPC) index hitting a record high. The dollar fell to a seven-month low against the euro, while prices for U.S. government bonds rose sharply.

"The economy is stabilizing but it's not growing," said Douglas Borthwick, managing director at Chapdelaine Foreign Exchange in New York. "The Fed has always said they were data-dependent and data would determine the timing of the taper. But the data that has come out over the past month hasn't been good."

In its statement, the Fed said the economy was still making progress, even in the face of tax hikes and budget cuts in Washington.
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"Taking into account the extent of federal fiscal retrenchment, the committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy," it said.

And policymakers made clear they were still mulling exactly when to ratchet back their bond-buying stimulus.

"The committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases."

Kansas City Federal Reserve Bank President Esther George again dissented, saying she was worried about financial bubbles due to the Fed's low rate policy.

The move comes against the backdrop of a somewhat gloomier outlook for economic growth from U.S. Fed officials.

In a new set of quarterly forecasts, the Fed said it now sees growth in a 2 percent to 2.3 percent range this year, down from 2.3 percent to 2.6 percent in its June estimates. The downgrade for next year was even sharper.

Most policymakers, 12 out of 17, also projected the first hike in overnight interest rates would not come until 2015, even though the forecasts suggested they would likely hit their threshold for considering a rate hike as early as next year.

The Fed reiterated that it won't start to raise rates at least until unemployment falls to 6.5 percent, so long as inflation doesn't threaten to go above 2.5 percent. The U.S. jobless rate in August was 7.3 percent.

Fed Sticks to Stimulus, Worried About Growth Soft Spots
The gross domestic product measures the level of economic activity within a country. To figure the number, the Bureau of Economic Analysis combines the total consumption of goods and services by private individuals and businesses; the total investment in capital for producing goods and services; the total amount spent and consumed by federal, state, and local government entities; and total net exports. It's important, because it serves as the primary gauge of whether the economy is growing or not. Most economists define a recession as two or more consecutive quarters of shrinking GDP.
The CPI measures current price levels for the goods and services that Americans buy. The Bureau of Labor Statistics collects price data on a basket of different items, ranging from necessities like food, clothing and housing to more discretionary expenses like eating out and entertainment. The resulting figure is then compared to those of previous months to determine the inflation rate, which is used in a variety of ways, including cost-of-living increases for Social Security and other government benefits.
The unemployment rate measures the percentage of workers within the total labor force who don't have a job, but who have looked for work in the past four weeks, and who are available to work. Those temporarily laid off from their jobs are also included as unemployed. Yet as critical as the figure is as a measure of how many people are out of work and therefore suffering financial hardship from a lack of a paycheck, one key item to note about the unemployment rate is that the number does not reflect workers who have stopped looking for work entirely. It's therefore important to look beyond the headline numbers to see whether the overall workforce is growing or shrinking.
The trade deficit measures the difference between the value of a nation's imported and exported goods. When exports exceed imports, a country runs a trade surplus. But in the U.S., imports have exceeded exports consistently for decades. The figure is important as a measure of U.S. competitiveness in the global market, as well as the nation's dependence on foreign countries.
Each month, the Bureau of Economic Analysis measures changes in the total amount of income that the U.S. population earns, as well as the total amount they spend on goods and services. But there's a reason we've combined them on one slide: In addition to being useful statistics separately for gauging Americans' earning power and spending activity, looking at those numbers in combination gives you a sense of how much people are saving for their future.
Consumers play a vital role in powering the overall economy, and so measures of how confident they are about the economy's prospects are important in predicting its future health. The Conference Board does a survey asking consumers to give their assessment of both current and future economic conditions, with questions about business and employment conditions as well as expected future family income.
The health of the housing market is closely tied to the overall direction of the broader economy. The S&P/Case-Shiller Home Price Index, named for economists Karl Case and Robert Shiller, provides a way to measure home prices, allowing comparisons not just across time but also among different markets in cities and regions of the nation. The number is important not just to home builders and home buyers, but to the millions of people with jobs related to housing and construction.
Most economic data provides a backward-looking view of what has already happened to the economy. But the Conference Board's Leading Economic Index attempts to gauge the future. To do so, the index looks at data on employment, manufacturing, home construction, consumer sentiment, and the stock and bond markets to put together a complete picture of expected economic conditions ahead.
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