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Fed must find its way back to normal

Published June 21. 2013 4:00AM

The dilemma confronting the Federal Reserve and its wizard, Chairman Ben Bernanke, was on full display this week. Mr. Bernanke's stated hint that the Fed might, at some future date, only if things improve, consider easing off on its easy money strategy sent markets tumbling.

Mr. Bernanke did not really say much at his Wednesday news conference, and much of what he said was good news. The Fed boosted its forecast for economic growth in 2014, predicting a range between 3 percent and 3.5 percent, substantially better than earlier predictions. It now estimates that next year the jobless rate could drop to 6.5 percent, after previously speculating it would remain as high as 7 percent.

You would think such a positive outlook would excite investors, but there was that subtle caveat about the Fed at some point easing its bond-buying policy. Mr. Bernanke did not say the bond buying will end anytime soon, in fact he anticipates it will continue well into next year. The central bank will only slow the borrowing if the jobs situation does indeed improve.

As for raising the fed funds interest rate, long near zero - forget about it - that will not happen at least until 2015, the chairman assured.

But apparently investors don't want any of it to end, ever. There are signs of addiction to the economic amphetamines the Fed used to stimulate the economy.

The central bank has been buying up $85 billion in bonds backed by housing mortgages every month, its latest version of "quantitative easing." The money comes in the form of credits on the accounts of big banks. This has made them more likely to lend, helping consumer purchasing and business growth. And because the Fed has focused on buying mortgage-backed bonds, the purchases have helped keep mortgage interest rates low to boost home sales.

And it has worked; the National Association of Realtors announced Thursday that sales last month increased from 4 percent over April and 13 percent from a year earlier, a sales pace not seen in several years. Average year-over-year housing prices increased 15 percent.

Yet it is a recovery built on a shaky and arguably false foundation. The Fed creates the money for all that bond borrowing out of thin air, just adding to the negative column on its balance sheet, now about $3 trillion. Installing a real foundation for economic growth without the whole thing crumbling will be a considerable challenge and it is not clear Mr. Benanke will be there to oversee it. His term ends in January and the chairman has not said whether he will seek another.

Mr. Bernanke acknowledge the Fed faces "a more complex type of situation" - unprecedented too. At some point it has to find a way to begin shrinking its balance sheet without igniting inflation or spooking the markets.

Mr. Bernanke and the Fed realized this is where the path they undertook with a series of quantitative easing initiatives would lead, and it was arguably the only path open to it in trying to rebuild an economy from the deepest recession since the Great Depression. The markets' overreaction to Mr. Bernanke's Thursday statements shows what a big challenge the Fed faces in trying to communicate its plans for scaling back. The giants of industry, meanwhile, must show a bit more confidence in the ability of the U.S. economy to function without the QE drug.

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