The Fed on a Tiger’s Back

NEW YORK – After two months of volatility in global financial markets, major equity indices in the United States have returned to their peaks. But bond markets and emerging economies remain deeply affected. Now, with major advanced-country central banks preparing to “taper” their quantitative-easing (QE) programs, the world must brace itself for additional bouts of financial turmoil in the next few years.

In fact, it took only the assertion by US Federal Reserve Chairman Ben Bernanke in May that, if the American economy continued to improve, the Fed would begin to reduce the pace of its securities purchases to unleash a short but significant financial-market sell-off. In order to ease global markets’ fears, which the Fed apparently assumes stem from a misunderstanding of Bernanke’s message, Fed officials have relied on various analogies in an effort to clarify their intentions.

For example, Bernanke explained that the Fed’s plan would be akin to a driver easing pressure on the gas pedal – not stepping on the brakes – as the car accelerates. Other officials liken their task to landing an airplane “stealthily” (that is, by powering down the motors and gliding steadily toward the ground). Still others are quitting smoking with the help of a nicotine patch.

Unfortunately, the Fed’s current quandary is more like riding the back of a tiger. It will be difficult for the Fed and other central banks to “dismount” from the QE programs without being devoured.