Fed's Unwinding Of Crisis Programs Expected To Push Up Interest Rates Very Gradually

Sep 20, 2017
Originally published on September 20, 2017 7:27 pm

The Federal Reserve on Wednesday said it will hold short-term interest rates steady for the time being. But the central bank said that in October it will begin to unwind the extraordinary stimulus it used to battle the Great Recession.

Fed Chair Janet Yellen has said the process will be gradual. But over the long run, the plan will put upward pressure on consumer interest rates, including for car loans and mortgages.

The Fed has already signaled the economy is strong enough to absorb higher short-term rates. It has raised them four times since the end of 2016. Wednesday's move to unwind its massive bond holdings is yet another sign of the Fed's confidence in the economy.

In November 2008, in the midst of the financial crisis, former Fed Vice Chair Alan Blinder says, the central bank had already exhausted its main tool to fight recessions. "[Fed Chair] Ben Bernanke and company were then literally at a crossroads," he says.

The Fed had reduced its benchmark interest rate to near zero, Blinder says. It could decide to say that's all we can do and "give up and hope for the best," or start inventing new instruments, he says.

Fed officials chose the second alternative and came up with something called quantitative easing. It entailed buying huge amounts, ultimately $1.7 trillion, of mortgage-backed securities, the very financial instruments that helped trigger the crisis. That helped stabilize the market for those securities and revive the housing market.

Over a series of three quantitative easing programs, the Fed also bought close to $2 trillion in Treasury bonds. That helped put more downward pressure on interest rates that supported borrowing and helped boost the economy. The program pushed the Fed's balance sheet from just under $1 trillion to $4.5 trillion in bonds and other securities.

On Wednesday, the Fed said it will begin to unwind that stimulus very gradually. In October, it will begin allowing about $4 billion worth of mortgage-backed securities and $6 billion of Treasury bonds to mature without reinvesting the proceeds. That will reduce the Fed's holdings by $10 billion. The Fed said it will not sell bonds or securities in the marketplace to avoid flooding and destabilizing the financial markets.

The Fed will gradually increase the amount of bonds it allows to mature. However, it will take years for the Fed to reach the level it sees as appropriate for the size of its balance sheet.

Over the long haul, the unwinding will put upward pressure on interest rates. But Blinder says he doubts consumer interest rates will be affected at all in the short term.

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Federal Reserve policymakers said today they're keeping interest rates where they are for now. But they also said that next month they'll begin retiring an innovative financial tool that used to battle the Great Recession. NPR's John Ydstie reports.

JOHN YDSTIE, BYLINE: You'll remember that as the recession worsened late in 2008, the Federal Reserve had already cut interest rates to near-zero to boost the economy. But the economy was still contracting, says Alan Blinder, a former vice chair of the Fed.

ALAN BLINDER: Ben Bernanke and company then were literally at a crossroads. So what do we do, give up and say that's all we've done and let's hope for the best, or start inventing new instruments?

YDSTIE: The Fed chair and his colleagues didn't give up. Instead they employed an unusual central bank tool called quantitative easing. They began by buying up mortgage-backed securities, the very financial instruments that triggered the financial crisis. The aim was to revive the housing sector. Also, the Fed started buying massive amounts of U.S. government bonds to help reduce long-term interest rates and support growth.

As a result, the assets on the Fed's balance sheet ballooned to $4.5 trillion from less than 1 trillion before the recession. Today Fed Chair Janet Yellen said the innovative program was a success.


JANET YELLEN: Stimulating a faster recovery than we otherwise would've had.

YDSTIE: A Fed research paper found quantitative easing lowered long-term interest rates by a full percentage point. Yellen said today the Fed's decision to wind down the program is a vote of confidence in the U.S. economy.


YELLEN: The decisions that we've made this year about rates and today about our balance sheet are ones we have taken because we feel the U.S. economy is performing well.

YDSTIE: The Fed is very gradually paring back its balance sheet to avoid spooking the financial markets. Those markets reacted calmly to the Fed action today. Alan Blinder says over the long run, the move will put upward pressure on interest rates.

BLINDER: If you're buying a car and you finance it with an auto loan, you'll pay a little more. If you're buying a house and getting a home mortgage, you'll pay a little more.

YDSTIE: But Blinder said that will happen very gradually over the next several years. John Ydstie, NPR News, Washington. Transcript provided by NPR, Copyright NPR.