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Fed mulls how to deliver tapering plan

Wednesday, December 11 16:15:51

Now that the central question before the Federal Reserve has shifted from whether to cut its extraordinary stimulus to when exactly to pull back, the debate at next week's meeting will center on how best to communicate that plan.

While recent and brisk improvements in the labor market have raised the chance that policymakers might taper at their meeting next week, most economists expect the Fed to keep its $85 billion-a-month bond-buying program in place for a bit longer.

But the Fed is expected to grapple with how much to telegraph about any plan to wind down its purchases, and to reinforce its commitment to keeping interest rates near zero even as it preps markets for the long road back to policy normalcy.

"What should be on the table is, Are there adjustments to our forward guidance that would reinforce the overall stance of policy that the Fed is trying to communicate?" the president of the Atlanta Fed, Dennis Lockhart, who is often seen as a bellwether for overall U.S. monetary policy, told reporters last week.

Central banks from Washington to Ottawa to Frankfurt have resorted to so-called forward guidance on interest rates in the wake of the Great Recession to convince financial markets they are serious about supporting recovery in the world's top economies for a long time to come.

If investors take central bankers at their word, the theory goes, borrowing costs should stay low enough to allow the economy to make up for lost ground.

To pull the U.S. economy from its worst downturn in decades, the Fed has kept short-term rates near zero. At the same time it has pushed down long-term borrowing costs by buying trillions of dollars in Treasuries and housing-backed securities.

Layered on top of that approach is the forward guidance - a critical and relatively new element in the Fed's strategy to boost investment and hiring.

Since December last year, the Fed has promised not to even consider raising rates until unemployment falls to at least 6.5 percent. Less precise but no less important is the Fed's guidance on asset-purchases - it will keep buying until the labor market outlook improves substantially.

Now that unemployment has fallen to 7 percent, from 10 percent four years ago, change is afoot.

The markets can handle a "small taper," St. Louis Fed President James Bullard, a policy centrist, told a group of investment advisers this week. Even the dovish chief of the Chicago Fed, Charles Evans, said in a recent interview he is "open-minded" to a reduction at the Dec. 17-18 meeting. (Reuters)