THE Federal Reserve concluded a two-day policy meeting last Wednesday, and, as expected, it was a snoozer.

The central bank is keeping up its $85 billion-a-month in bond purchases (that is, not starting to taper them now), along with its near-zero interest rates.

But while it was a snoozer in terms of policy changes, there were some details in the Fed’s policy statement that offer a useful lesson in how they’re thinking about the economy — and how the central bank’s policies will intersect with financial markets and the economy in the months and years ahead.

First, some new language. The Fed said in its statement that evidence suggests “the recovery in the housing sector slowed somewhat in recent months.” Later, they deleted a point that had been included in their September statement. Six weeks ago, Fed officials said that “the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labour market.”

These two points are related in important ways. Back in the spring and summer (and especially at its June policy meeting), the Fed was signalling it would soon begin tapering bond purchases. This caused financial markets to sell off at the prospect of less easy money from the Fed flooding the system: stocks, bonds, almost anything else you can imagine took a dive.

Falling stock and bond prices mean higher long-term interest rates and wider spreads between the risk-free assets like Treasury bonds and private borrowing costs for home mortgages or companies looking to expand.

That’s what the Fed was referring to as tighter financial conditions: in effect, because of an (arguably outsized) market reaction to their policy pronouncements, interest rates rose so high as to put the recovery at risk.

That was particularly true for housing: The rate on a 30-year, fixed-rate mortgage rose from 3.4 per cent at the end of April to a high of 4.7 per cent in September. Higher rates are surely a major contributor to the slowdown in the housing recovery that the Fed noted last Wednesday.

You can see the weird circularity here. The Fed thought the recovery was going okay back in the summer, so signalled a taper. That signalling drove a sell-off in markets. That sell-off drove up interest rates, and so the Fed decided not to taper in September, after all, worried about tight financial conditions — that the Fed itself had brought on!

It’s the Mobius Strip challenge for the Fed’s exit strategy or, to be less charitable, a snake eating itself. By taking away the line about too-tight financial conditions in Wednesday’s statement, the Fed was likely implying that it’s generally comfortable with where rates have settled since its September meeting. Mortgage rates haven’t fallen back to their spring lows, but they are down to 4.15 per cent, a major pullback from last month.

The Fed view seems to be this: conditions were too loose (e.g., bubbly) in April. They were too tight in September. But October appears to feel just right.

The job now for the Fed is figuring out how to manage the wind-down of bond-buying in a way that doesn’t cause these two extremes — either rates rising too much and killing the recovery, or rising too little and stoking bubbles. As Janet Yellen prepares to take over as chairwoman (assuming she is confirmed), this is the great challenge she will inherit.—Washington Post