Fed takes prudence to heart

August 12, 2009

The Federal Reserve’s decision to stretch out its $300 billion Treasury purchase program by an extra month is a sensible solution to the tricky problem of getting out of the intervention business.

It allows the Fed to begin unwinding the extraordinary measures put in place earlier this year to steady credit markets, but it gives it more time to wean markets off its support.

The program was expected to expire in September. Members of the policy-setting Federal Open Market Committee said Wednesday they now plan to slow purchases so they can wrap it up by the end of October.

The Fed has already spent the vast bulk of the $300 billion aimed at keeping a lid on Treasury yields and stimulating activity in credit markets. So stretching the remaining purchases into October is more symbolic than likely to have a meaningful impact on yields. Yet, it shows policymakers are still cautious when it comes to pulling the plug on unprecedented policies that have resuscitated capital markets after their near-death experience. And they should be.

Despite expectations for a snapback in the U.S. economy in the second half of the year, financial markets and the economy are still in uncharted territory when it comes to wringing out the excesses from this decade’s bubble. Fears that a premature exit will facilitate a double dip in the economy, as seen in the Depression, still linger.

And there’s little to lose by giving markets more time to adjust and policymakers more time to study how ending such a program is received.

The exit from the Treasuries market marks one of the most significant retreats yet for the Fed, and the markets’ response will influence how policymakers tackle the remaining programs, many of which are bigger and more significant.

Notably in Wednesday’s statement from the FOMC, policymakers didn’t try to do too much. The larger program — its plan to buy up to $1.25 trillion of mortgage-backed securities and $200 billion in agency debt — is still on track to expire at the end of the year. And interest rates will continue at their rock bottom 0-0.25 percent range for “an extended period.”

This “steady as she goes” approach is prudent. Now let’s see if it works.

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