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The ""Federal Reserve"":http://www.federalreserve.gov/default.htm will continue its current policy of buying up $40 billion in agency mortgage-backed securities (MBS) and $45 billion in Treasuries per month as long as economic conditions warrant such measures, explained ""Federal Reserve Chairman Ben Bernanke"":http://www.federalreserve.gov/aboutthefed/bios/board/bernanke.htm during a ""testimony"":http://www.federalreserve.gov/newsevents/testimony/bernanke20130717a.htm given Wednesday before the House of Representatives Committee on Financial Services.
[IMAGE]""I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a preset course,"" Bernanke said.
This assertion is nothing new, according to Paul Dales, senior economist at Capital Economics. However, ""the message that the tapering of QE3 is not set in stone and that the end of the asset purchases won't be immediately followed by higher interest rates is increasingly getting through to the markets,"" Dales said in response to Bernanke's testimony.
In purchasing MBS and Treasuries, the Fed aims to effect ""substantial improvement in the labor market."" Together the asset purchases and the Fed's ""forward guidance"" also work to keep interest rates low.
While the labor market is on the mend, Bernanke and the Federal Open Market Committee (FOMC) are looking for more improvement before discontinuing their current fiscal policies.
[COLUMN_BREAK]In June, FOMC revealed several positive projections for the economy, including acceleration in GDP growth, improving employment, and a slight increase in inflation.
By 2015, FOMC predicted GDP growth will be between 2.9 and 3.6 percent; unemployment will be between 5.8 and 6.2 percent; and inflation will be near a healthy 2 percent.
While most readily identify the negative impact of high inflation, Bernanke pointed out low inflation poses risks of its own by raising the real cost of capital investment and posing the threat of deflation.
However, FOMC suggested recent low inflation will be back near 2 percent by 2015.
Should these projections pan out, the Fed will begin reducing the pace of its asset purchases by the end of this year and stop them completely by the middle of next year.
However, if economic conditions do not fall in line with FOMC's favorable projections, the Fed will continue on its current purchase path.
Additionally, when the Fed ceases asset purchases, it will not release them to the market immediately. Holding the assets and reinvesting any resulting earnings will further contribute to economic recovery because these actions will ""put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative,"" according to Bernanke's testimony.
Bernanke's testimony did not alter Dales' expectation that the Fed will ""begin to slow the pace of its asset purchases at the meeting scheduled for September and end them completely in June next year.""
Dales also expects ""the first interest rate hike won't come until the first half of 2015 and that and the end of that year interest rates will still be as low as 1.0%.""
