It’s not always wise to judge economic events by Wall Street’s reaction. But there was a rational basis for the markets’ ecstatic response to Federal Reserve Chairman Ben Bernanke’s announcement Wednesday of a “taper” in central-bank asset purchases. Part of the Fed’s unconventional response to the Great Recession has been a massive expansion of its balance sheet, including the recent addition of about $85 billion per month in government or government-backed securities. The Fed’s decision to decelerate bond-buying, starting with a $10 billion reduction in January, is a sign of confidence that the economy is starting to stand on its own two feet.
Equally important, the incipient taper signals the central bank’s belief that political risks to the economy are diminishing. The Fed embarked on its latest round of bond-buying a little more than a year ago, at a time when partisan disagreements on Capitol Hill were about to send the United States over a recessionary “fiscal cliff.” Now, by contrast, Republicans and Democrats have struck a budget deal that probably eliminates the threat of a government shutdown for two years and even boosts spending modestly in the short run.