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By Jason Stipp and Robert Johnson, CFA | 09-18-2013 03:00 PM

Behind the Fed's Taper Tactics

Morningstar's Bob Johnson on the Federal Reserve's rationale for continuing its bond-buying program and what it means for interest rates, the economy, and the Fed's options going forward.

Jason Stipp: I'm Jason Stipp for Morningstar. The Federal Reserve surprised everyone on Wednesday by announcing that they would continue their bond purchases, $85 billion a month of bond purchases, whereas most people expected them to start tapering. The market liked the news, but what was really behind the decision? Here to offer his insights is Morningstar's Bob Johnson, our director of economic analysis.

Thanks for joining me Bob.

Bob Johnson: Great to be here.

Stipp: What exactly caused the Fed to make this decision? Almost everyone thought they would at least modestly start to taper those bond purchases, and they said, not so fast, we're not going to do it yet.

Johnson: Yes. The key thing the Fed said is the broad contours of things [were similar to how] they were in June, when they first thought about this, but they also said that they needed some more confirming data to really come to that conclusion. There were number of things on their mind that caused them I think to back away.

One of them is certainly, that they mentioned again and again, fiscal policy, that is the money that Congress agrees to spend every year. [Fed chairman Ben Bernanke] said that those policies have been remarkably tight. And right now, we have not got a budget for 2014 yet, and that we're coming up on the deadline. There are threats to shut down the government and some real acrimonious debates right now going on. And I think they were little fearful that they didn't want that going on, the threat of government shutdown coming on the same day that they physically stop buying the bonds.

Stipp: Yes, it's essentially a double whammy, potentially if we have a real government shutdown or a stoppage in the fiscal situation because of the wrangling.

Johnson: Exactly. They've always felt a little bit that their loose monetary policy was based on how tight the fiscal policy, that is the government spending. Those are two arms of improving an economy, as you have easy monetary policies and you have easy fiscal policies. Fiscal was unbelievably tight. We talked a little bit in last week's column. We went from a $1.1 billion deficit to a $600 million estimated of a budget deficit in one year. We've probably never seen a deficit come down that much in one year. And that's a lot of pain to absorb.

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