Fed pulls the plug on its stimulus program

With the U.S. economy showing signs of life, the Federal Reserve moved Wednesday to end billions of dollars in monthly bond purchases aimed at boosting growth.

The central bank had initiated the policy, known as "quantitative easing," in 2008 to keep interest rates low and boost economic activity following the financial crisis. Six years later, Fed officials said in a policy statement that the economy is improving at a "moderate" pace.

But in a notable upgrade to its outlook, the Fed said that the job market is showing stronger gains and that "underutilization of labor resources is gradually diminishing." In September, policymakers said there remained "significant underutilization" of labor resources. The Fed also said that labor market conditions had improved further with "solid job gains and a lower unemployment rate."

Although the Fed said it plans to keep interest rates low for a "considerable" time, investors seemed to think the first rate hike could come sooner rather than later. The Dow Jones industrial average, which had stayed mostly flat in the hours leading up to the Fed's latest policy statement, dipped after the announcement.

"This is a small but significant step towards the first tightening, though action is not yet imminent given the still sticky 2 percent pace of wage gains," said Ian Shepherdson, chief economist with Pantheon Macroeconomics, in a research note.

The change in the Fed's view of employment indicates that the Fed believes that the job market, while not completely restored following the Great Recession, is at least in better shape. One of the Fed's major goals is to achieve maximum employment, which it currently defines as an unemployment rate between 5.2 percent and 5.5 percent. The unemployment rate in September fell to 5.9 percent.

The decision was approved with a 9-1 vote. The one dissent came from Narayana Kocherlakota, the president of the Fed's regional bank in Minneapolis. He objected, contending that the Fed should have changed its rate hike guidance to link it to inflation expectations rising to the Fed's 2 percent target. He also argued that in light of the recent slide in the market's expectations for future inflation, the Fed should also have continued its bond purchase program at the current level of $15 billion.

Kocherlakota is considered one of the Fed's leading "doves," Fed officials who are more concerned about unemployment than the risk that low interest rates could trigger inflation. At the last meeting in September two "hawks," Fed officials who are more concerned about inflation threats, Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher, had dissented.

The U.S. economy has been benefiting from solid consumer and business spending, manufacturing growth and a surge in hiring that's reduced the unemployment rate to a six-year low of 5.9 percent. Still, the housing industry is still struggling, and global weakness poses a potential threat to U.S. growth.

Fed Chair Janet Yellen has stressed that while the unemployment rate is close to a historically normal level, other gauges of the job market remain a concern. These include stagnant pay; many part-time workers who can't find full-time jobs; and a historically high number of people who have given up looking for a job and are no longer counted as unemployed.

What's more, inflation remains so low it isn't even reaching the Fed's long-term target rate of 2 percent. When inflation is excessively low, people sometimes delay purchases - a trend that slows consumer spending, the economy's main fuel. The low short-term rates the Fed has engineered are intended, in part, to lift inflation.

Investors are expected to remain on high alert for the first hint that rates are set to move higher. Most economists have said they think the Fed will start raising rates by mid-2015. But global economic weakness, market turmoil and falling inflation forecasts have led some to suggest that the Fed might now wait longer.

The Fed's decision to end its third round of bond buying had been expected. It has gradually pared the purchases from $85 billion in Treasury and mortgage bonds each month to $15 billion. And the Fed had said it would likely end the program after its October meeting if the economy continued to improve.

Even with the end of new purchases, the Fed's investment holdings stand at $4.5 trillion - more than $3 trillion higher than when the bond purchases were launched in 2008 at the height of the financial crisis. The Fed has said it won't begin selling its holdings until after it starts raising short-term rates.

Most economists have predicted that the Fed's first rate hike won't occur until next summer. Some foresee no increase until fall, in part because of fears that the global economy is weakening and could threaten the U.S. economy.