Big Ben went small. And that is probably a good thing.
Rather than come in guns blazing in the wake of Monday's market rout, the Federal Reserve chose at its Tuesday meeting to hold off on extreme measures, notably the resumption of purchases of government bonds that some investors had hoped for. Instead, Chairman Ben Bernanke and the Fed opted only to change language for how long it expects to keep interest rates near zero until 'at least mid-2013'; previously, the Fed only said rates would be kept low for "an extended period."
As unprecedented as this was, it still fell short of what some in markets expected. Not that it immediately mattered -- stocks soared. That was likely due to the prospect of rates staying low for so long, but also possibly because the Fed didn't rule out more bond buys down the road.
The Fed did raise more concerns about the economy and what is causing growth to falter, noting temporary factors such as Japan's natural disasters, "appear to account for only some of the recent weakness in economic activity."
Even so, economic conditions are hardly dire enough for the Fed to again prop up markets. With fewer arrows left in its quiver, it will have to bide its time. This is especially the case given three Fed members dissented from the statement because they thought the 'extended period' language shouldn't have been changed. This shows the Fed is divided at the moment over the growth outlook and what should be done about it.
Moving too fast also holds other risks. A quick reversal on asset purchases would have looked schizophrenic given that just two months ago it opted to let its previous, $600 billion bond-buying program expire as planned. It also isn't clear how much impact additional bond buying would have on the economy and job growth. Even if the last bond-buying program helped -- an issue still the subject of much debate -- the Fed risks getting less and less bang for its buck.
Plus, banks aren't in the kind of dire straits that necessitate central-bank action. The financial system is awash in liquidity and credit markets are functioning.
Perhaps the biggest reason for the Fed to hold back: By not riding to the markets' rescue, it may put more pressure on politicians in Washington. Just as markets have become overly reliant on the Fed, Washington also has become too confident that even if it dithers, Bernanke & Co. will do the heavy lifting.
If the Fed put the ball back in the government's court, politicians may feel added impetus to deal with thorny economic issues. After all, as Mr. Bernanke has repeatedly said, the Fed can only do so much.
True, the Fed isn't likely to stand by if deflation again becomes a threat. But for now, the Fed is right to let markets find their own footing and demand the government does its part to shore up the economy.