Fed stuns markets, sticks with stimulus

The Federal Reserve made the surprise decision to stick with economic stimulus on Wednesday as its chairman expressed grave concern about the fiscal standoff in Washington.

Fed Chairman Ben Bernanke said there were several reasons why the central bank decided to stick with its massive bond buys — not least the fight in Congress over federal spending and the debt ceiling.

{mosads}”Upcoming fiscal debates may involve additional risks to financial markets and the broader economy,” Bernanke said at a press conference. “In light of these uncertainties, the committee decided to wait for more evidence.”

Investors had broadly expected officials would use the September policy meeting to announce long-awaited plans to begin winding down its “quantitative easing.”

Instead, the central bank announced it was going to continue buying $85 billion of bonds each month to support the economy.

Stock traders were gleeful at the news, propelling the Dow Jones Industrial Average and S&P 500 to all-time highs.

But there was no celebrating at the Fed, where Bernanke delivered a timeworn refrain about the dangers facing the economy.

With both parties digging in over a government shutdown and the debt limit, Bernanke warned that the Fed’s ability to protect the economy has limits.

“A government shutdown, and perhaps even more, a failure to raise the debt limit, could have very serious consequences for the financial markets and for the economy, and the Federal Reserve’s policy is to do whatever we can to keep the economy on course,” he said.

“Make sure the government is funded … that the government pays its bills and that we avoid any kind of event like 2011,” he added, referring to the last major debt-limit fight that roiled markets and damaged the nation’s credit rating.

In its policy statement, the Federal Open Market Committee said it would stick with its $85 billion in monthly bond purchases until officials see more evidence that the economic recovery is self-sustaining.

The Fed said one of the primary reasons for the decision was the fiscal fight in Washington, which it said is “restraining economic growth.” The central bank also noted that mortgage rates had spiked since Bernanke announced the Fed was preparing to slow down its stimulus.

Bernanke previously laid out the Fed’s plan for slowing and, ultimately, ending its stimulus at a July press conference. There, he said that if the economy proceeds as expected, the Fed would eventually end its bond purchases by mid-2014.

While investors were expecting a shift in policy Wednesday, Bernanke defended the decision to stay the course.

“We can’t let market expectations dictate our policy actions,” he said.

The Fed has repeatedly emphasized that its plan to stop stimulus will be heavily dependent on incoming economic data. If the economic recovery hits a rough path, Bernanke and fellow Fed officials have said they will be prepared to step back on the gas if necessary.

In fact, Bernanke said that if developments in Washington spiral out of control, the Fed would consider ordering even more stimulus to minimize the damage.

The new policy statement indicates that while the Fed is confident in the underlying strength of the economy, even in the face of “federal fiscal retrenchment,” it wants to see more evidence of a recovery before pulling back.

The Fed launched its third and most recent round of easing a little over a year ago, committing to the purchase of $45 billion of Treasury bonds and $40 billion of mortgage debt each month. The central bank said it planned to keep up those purchases until it saw substantial improvement in the labor market.

The Fed also announced Wednesday it planned to keep interest rates near zero.

— This story was first posted at 2:22 p.m. and has been updated.

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