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Fed To Buy $1 Tril In Assets Next Year As It Expands QE

The Federal Reserve more than doubled the rate of its net bond buying and set guidelines for keeping interest rates near zero that explicitly tolerate short-term inflation above its 2% target.

As expected, the central bank will create $85 billion a month to buy mortgage-backed securities and Treasury bonds, up from its current pace of $40 billion in so-called quantitative easing.

While the Fed can adjust its bond purchases based on economic conditions, $85 billion a month adds up to $1.02 trillion over 2013, adding to the more than $2 trillion in assets bought since the start of the financial crisis.

The extra QE will replace the expiring Operation Twist, a program for lowering long-term rates by selling short-term bonds and buying an equivalent amount of longer-dated ones.

'Guideposts' Not Triggers

For the first time, the Fed also established data-based thresholds for maintaining the benchmark rate near zero, moving away from a calendar-based approach sooner than expected.

They include unemployment above 6.5%, near-term inflation no higher than 2.5%, and stable long-term inflation views. But data outside those "guideposts" wouldn't trigger immediate tightening, Bernanke said.

"It by no means puts monetary policy on autopilot," he told reporters.

For example, if the jobless rate dips below 6.5% but inflation expectations remain low, tightening might still be inappropriate, he explained.

Policymakers will see if unemployment falls because more people got jobs vs. gave up looking for work, as was the case when the rate dropped last month.

The inflation threshold is also the projected rate, not the current one. That's meant to look past short-term effects from commodity price swings.

"They left themselves a lot of wiggle room," said Brian Jones, a senior U.S. economist at Societe Generale.

Though Bernanke reiterated that the Fed isn't favoring employment over price stability, Jones sees a clear focus on reducing unemployment, noting that inflation tends to lag labor market improvements.

Critics of the Fed's easy-money policies have warned they could stoke inflation, but it has been subdued recently. Fed policymakers continue to see it at 2% or less through 2015, and they cut the low end of views.

The Fed also slightly trimmed its GDP projections. Its 2013 range is seen at 2.3%-3% vs. 2.5%-3%, 2014 to 3%-3.5% from 3%-3.8%, and 2015's high end was shaved to 3.7% from 3.8%. The central bank doesn't see joblessness hitting 6.5% until 2015.

But the $45 billion in additional QE each month will pack a bigger economic punch than Operation Twist's purchases of an equal amount, because the latter was offset with short-term sales.

St. Louis Fed President James Bullard suggested earlier in December that $25 billion in more QE would have the same effect as Twist.

That's why University of Oregon economist Tim Duy expected the Fed to add less than $45 billion a month to QE. But Bernanke downplayed the economic impact of the heavy money printing in his press conference.

Despite the Fed's bulked-up QE and greater inflation tolerance, Duy doesn't see a plan to deliberately raise price pressures to nudge the economy forward.

"There's no indication of allowing inflation to rise as a policy tool," he said.