It marks the first big step toward unwinding the massive stimulus the Fed has pumped into the economy since the 2008 financial crisis and Great Recession.
STOCKS WEDNESDAY: Markets react to Fed news
FIRST TAKE: Fed move demonstrates economy's growing strength
FED STATEMENT: Full text
In a statement after a two-day meeting, the Fed said, that starting in January, it will buy $75 billion a month in government bonds, down from $85 billion a month since October 2012. The Fed will purchase $40 billion in Treasury bonds, down from $45 billion previously, and $35 billion in mortgage-backed securities, down from $40 billion. The purchases are intended to hold down interest rates and spur economic and job growth.
Fed policymakers said they would likely continue to trim the purchases "in further measured steps at future meetings." But they added the purchases "are not on a preset course" and they could adjust the pace based on the labor market outlook, inflation and the program's risks.
The Fed's policymaking committee "sees the improvement in economic activity and labor market conditions (since it began the purchases in September 2012) as consistent with growing strength in the broader economy," the Fed said. The jobless rate has fallen to 7% last month from 8.1% in fall 2012.
Boston Fed President Eric Rosengren was the lone dissenter. With unemployment still elevated and inflation well below the Fed's target, Rosengren believes that tapering "is premature until incoming data more clearly indicate that economic growth is likely to be sustained above its potential rate," the statement said.
Many economists expected that, along with tapering, the Fed would lower its unemployment threshold for how long it will keep its benchmark short-term interest rate near zero from 6.5% to 6%. That would stress that taper! ing does not signal an earlier rise in short-term rates.
Although the Fed did not formally lower the threshold, it added that it expects to keep the benchmark rate near zero "well past the time that the unemployment rate declines below" 6.5%, especially if projected inflation continues to run below" the Fed's 2% target. Inflation, excluding food and energy, has been running at a 1.1% annual rate—the sign of a still-sluggish economy.
The Fed slightly upgraded its economic outlook. It now expects the economy to grow at a 2.2% to 2.3% annual rate this year, up from its September forecast of 2% to 2.3%. It predicts the economy will grow 2.8% to 3.2% in 2014, vs. its previous projection of 2.9% to 3.1%.
The unemployment rate is projected to fall to 6.3% to 6.6% by the end of next year, lower than its previous forecast of 6.4% to 6.8%. The Fed expects the jobless rate to be 5.8% to 6.1% by the end of 2015.
Just a handful of the 34 economists USA TODAY surveyed last week predicted the Fed would reduce the bond purchases this week, but a slight majority said the tapering would begin by January, while many others picked March.
The question of when the Fed will begin to trim the purchases has transfixed Wall Street for months. The Feds stunned financial markets in September by putting off the tapering amid weaker economic data and stood pat again in October. But the odds of the Fed acting in December rose recently as reports showed a strengthening economy.
Monthly job growth has averaged a solid 200,000 the past four months despite the federal government shutdown. In November, housing starts increased at the fastest pace in nearly six years and manufacturing output posted its strongest growth since late 2012.
Congress is poised to pass a two-year budget deal that would alleviate uncertainty among businesses over tax and spending policy.
At the same time, inflation has been running well below normal, theoretically giving the Fed more flexibility to keep the stimul! us going ! and await more signs that the economy will continue to improve.
Since September 2012, the Fed each month has purchased $45 billion in Treasuries and $40 billion in mortgage-backed securities to push down long-term interest rates and stimulate more home and car purchases and business investment. The low rates also have driven investments to riskier assets, fueling a stock market rally.
But Fed policymakers have grown increasingly concerned about the risks of the bond-buying, such as eventual high inflation and the formation of bubbles in real estate, junk bonds and other assets.
Since the Fed began signaling in May that it may soon begin to dial down the purchases, interest rates have drifted higher, with 30-year fixed mortgage rates rising to 4.42% from 3.35%. The rising rates helped convince the Fed to delay tapering in September.
Further complicating the picture is that Fed Chairman Ben Bernanke plans to step down when his term ends in January. Vice Chair Janet Yellen, who has been nominated to succeed him, has expressed an even more pro-growth approach but must deal with a policymaking committee with diverse views of the stimulus.
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