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Fed needs to reduce monetary easing carefully

The US Federal Reserve Board has taken a step toward modifying the extraordinary easy-money policy that it put in place to deal with the financial crisis.

The road to an "exit strategy" for ending the quantitative monetary easing is long. The Fed will be pressed to steer the difficult process in a way that will not bring about confusion in the market.

The central bank has decided to begin the tapering of its "QE3" policy next month by implementing a monthly $10 billion reduction in bond purchases. Under the policy, the Fed has been buying $85 billion a month of US government bonds.

The US jobless rate dropped to 7 per cent in November, the lowest in five years. Housing starts have risen, and the real gross domestic product in the July-September quarter increased by 4.1 per cent compared to the previous quarter.

The economic recovery and improvement in the employment situation can be said to have pushed the Fed to decide to scale down its quantitative easing policy.

As the ruling and opposition parties in Congress have agreed on fiscal negotiations, future partial government shutdowns are expected to be prevented. The fading uncertainty on the fiscal front is also a factor in the Fed's latest decision.

Yet the central bank indicated it will hold its short-term rate near zero well past the time when the unemployment rate falls below 6.5 per cent, the rate the Fed had considered the trigger to end its policy.

Stock prices, including those on the New York Stock Exchange, have been rising. It is praiseworthy that the Fed's latest action has spread a sense of ease in the markets, with its decisions to scale down the quantitative monetary easing only moderately; not hastily end the policy of holding its short-term rate near zero; and leave any belt-tightening for well into the future.

Meanwhile, the dollar is likely to remain strong against the yen, as there is strong dollar-buying pressure in the market against the backdrop of a US economic recovery.

The focal issue from now on will be at what pace the Fed will scale down the quantitative easing policy from next year onward.

The Fed said it expects to make "similar moderate" cuts in its bond purchases if economic gains, as indicated in employment and other data, continue. Yet specific measures remain unknown. It is important for the Fed to devise ways to hold what it calls "dialogues with the market," and smoothly implement its tapering measures.

As the US monetary easing has been in place for five years, excess funds have circulated around the globe, causing fears of asset-inflated bubbles in emerging economies and elsewhere.

At the same time, such developments as a rapid scale-down in monetary easing that would accelerate the flow of these funds out of emerging markets and rock the global economy must be avoided.

The Fed must meticulously manage its policy, keeping an eye on changes not only in the US economy but also in emerging markets.

Fed vice chairman Janet Yellen, who will succeed chairman Ben Bernanke, will assume this heavy responsibility. The ability of Yellen, who attaches great importance to the employment situation and is positive about monetary easing, will be tested in this respect.

Sooner or later, the Bank of Japan will have to face the problems of fashioning an exit strategy, like the Fed is doing now.


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