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Here's how the Fed's plan helps economy

Why has the Federal Reserve been buying so many bonds?

To stimulate the economy. Normally, when there's a recession or the economy is limping along, the Federal Reserve will reduce short-term interest rates to spur more lending and spending. But interest rates are already very low, so the Fed had to turn to less conventional tactics, including quantitative easing.

In QE, as it is often called, the Fed buys up assets like long-term Treasury bonds or mortgage-backed securities from commercial banks and other institutions. The idea is that all that bond buying reduces the cost of borrowing money for corporations, brings down mortgage rates even further and potentially boosts the stock market, increasing wealth effects for consumers to spur more spending. The increase in spending then boosts the overall economy.

What happened Wednesday?

The Federal Reserve announced that it would lower its bond buying from $85 billion a month to $75 billion, with the possibility of further reductions after any of its eight scheduled meetings in 2014.

Why ease up now?

Federal Reserve chairman Ben Bernanke said he and his colleagues believe the economy is improving and that they had an increased confidence in the country's job market. He remained open to increasing the bond buying if data shows the economy starting to stall again.

"The steps that we take will be data dependent," he said. "If we're making progress in terms of inflation and continued job gains, then I imagine we'll continue to do, probably at each meeting, a measured reduction" in purchases. If the economy slows, the Fed could "skip a meeting or two," and if the economy accelerates it could taper a "bit faster," he said.

Here's how the Fed's plan helps economy 12/18/13 [Last modified: Wednesday, December 18, 2013 9:57pm]
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