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Federal Reserve To 'Unwind' Holdings

DAVID GREENE, HOST:

In this afternoon, the Federal Reserve is expected to embark on a great unwinding. So what is that? Well, it means the Fed is going to begin to shrink this $4 trillion portfolio of bonds and mortgages it has. They built up this portfolio over the last decade to revive a struggling economy.

I'm going to stop talking now because we should hear from someone who actually knows this stuff. It is David Wessel, director of the Hutchins Center at the Brookings Institution also a contributing correspondent to The Wall Street Journal. And of course, you've heard him on this program many times.

Hey there, David.

DAVID WESSEL: Good morning.

GREENE: So is this this thing called quantitative easing that you and I talk so much about - this big experiment that the Fed did to try and help the economy?

WESSEL: Yes. Basically, back in 2008, the Fed cut short-term interest rates to zero. That wasn't enough to rescue the sinking economy, so it launched this experiment - quantitative easing - printing money to buy more than $3 trillion dollars in bonds to try and push down long-term interest rates - the ones that set mortgages and the ones that influence what businesses pay to borrow.

Now, it stopped adding to this portfolio a few years ago. But it held off on actually shrinking it until it was persuaded that the economy was kind of strong enough to take it. Well, unemployment is now at a 16-year low. Hiring is a pretty good pace. The rest of the world is doing better. So the Feds basically decided it's time to let the economy begin to stand on its own. It's not quite declaring mission accomplished. But it's a first step toward saying that.

GREENE: OK. So if you're the Fed, you buy all this stuff to push down interest rates. Do you now sell these bonds and mortgages or what happens?

WESSEL: No. That's a kind of a common misconception. What they're likely to say this afternoon - that they'll gradually allow this portfolio to shrink, not by selling anything, but by reinvesting the proceeds - when a bond matures or someone pays off their mortgage.

So it's going to be very gradual. There's an economist up in Columbia, Rich Clarida, who told The Wall Street Journal the other day that this is kind of like losing weight by eating only two desserts instead of three.

GREENE: (Laughter) Well, that doesn't sound that terrible.

WESSEL: (Laughter).

GREENE: But, well - but is it a bad thing for consumers, though? I mean, if everyone's gotten used to these low interest rates, is getting a mortgage and things like that going to be a lot more expensive now?

WESSEL: Yeah. I mean, logically, if buying trillions of dollars in bonds pushed down mortgages and other long-term interest rates - the Fed economists say they think rates are about a full percentage point lower than they would have been if they hadn't done that - then, obviously, if you stopped doing that, if you shrink a little bit, it'll have the opposite effect and push rates up.

Now, the Fed is hoping that by advertising its plans well in advance and moving very gradually, that it can avoid unsettling the financial markets and triggering a reaction from the bond market where these rates are set that leads to a sharp increase in rates. So there's going to be some increase in interest rates.

The Fed's never done anything before like this. So they can't be certain what the effects will be. I think it's a sign, though, of the Fed's confidence in the economy that it's finally willing to take this step.

GREENE: OK. So the message is this could feel bad if you're not getting the low mortgage rates and interest rates that you've gotten before. But overall, you should feel like this is a good step because it's a sign that the economy is improving and should make you feel more confident.

WESSEL: Yes, as long as the Fed is not miscalculating - if the Fed is not overly optimistic about the strength of the economy.

GREENE: All right. That is David Wessel - he is director of the Hutchins Center at the Brookings Institution, also a contributing correspondent to The Wall Street Journal - speaking to us about the great unwinding. It sounds like a novel that we're going to be hearing about from the Fed today. David, thanks as always. We appreciate it.

WESSEL: You're welcome.

(SOUNDBITE OF HAROLD LOPEZ-NUSSA'S "CIMARRON") Transcript provided by NPR, Copyright NPR.