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Even so, rates on home loans are expected to remain low. To foster the recovery, the Fed also decided to hold the target range for its key bank lending rate at a record low of between zero and 0.25 percent.
Stocks fell as a brief rally followed the Fed's statement and then faded. The Dow Jones industrial average came within 82 points of crossing 10,000 for the first time since October but ended with a loss of 81.
Stocks often trade erratically on days when the Fed issues policy decisions as investors pore over the statement. Some analysts said the Fed's statement was anticipated and didn't give the market enough reason to go higher -- especially with stock indicators up more than 50 percent from their March lows.
"The market got exactly what it was expecting," said Thomas Wilson, a managing director at Brinker Capital in Berwyn, Pa.
Wilson cautioned, though: "I think there is a real concern out there that this is just a head fake and the stimulus out there is temporary," pointing to the Fed's slowing of its purchases of mortgage-backed securities.
With the economy on the mend, the Fed said it now plans to reach its goal of buying $1.45 trillion in mortgage-backed securities and debt by the end of March, rather than by the end of this year as originally scheduled. It's the second time since August that the Fed has opted to slow emergency programs designed to encourage spending and boost the economy.
Those decisions show Fed Chairman Ben Bernanke and his colleagues are shifting from managing the financial and economic crises to nurturing a budding recovery.
In a far brighter assessment, Fed policymakers said: "Economic activity has picked up following its severe downturn." In August, policymakers had said economic activity was "leveling out."
The Fed again pledged to keep its key lending rate at a record low "for an extended period." Economists predict that means through the rest of this year and perhaps into part of next year.
Holding that rate steady means commercial banks' prime lending rate -- used to peg rates on home equity loans, certain credit cards and other consumer loans -- will stay at about 3.25 percent, the lowest in decades. The goal is to entice people and businesses to step up spending to aid economic growth.
Yet even so, Fed policymakers predict inflation will remain "subdued for some time."
Analysts say mortgage rates should remain low for now but could eventually head higher. That's why homeowners who want to refinance mortgages shouldn't delay, said Greg McBride, senior financial analyst at Bankrate.com.
McBride said rates will eventually be pushed up by the Fed's gradual withdrawal from the market, the strengthening housing market and the likely increase in inflation as the economy stabilizes.
Refinancing is especially urgent for people eligible for a separate government-backed refinance program, which expires in June, McBride said. But he said homeowners in adjustable-rate loans whose payments fell this year also need to move quickly.
"They could be tempted to put their heads in the sand on refinancing for another 12 months," he said. "It could be a different story 12 months from now," with much higher rates for 30-year fixed rate mortgages.
In their more optimistic outlook, policymakers noted that financial conditions and the housing market have improved. Those observations build on Bernanke's declaration last week that the recession is "very likely over."
They also cautioned, though, that other factors could weigh down the recovery. Consumer spending -- the lifeblood of economic activity -- remains constrained by job losses, sluggish income growth, lower housing wealth and still hard-to-get-credit.
Even though the Fed will slow its purchases of mortgage securities, rates for home loans should remain low "in the 5 percent range" as long as the purchases continue, said Guy Cecala, publisher of Inside Mortgage Finance.
The program has helped the housing market, which led the country into recession. Home sales have firmed, and mortgage rates have dropped. Rates on 30-year home loans fell to 5.04 percent last week, compared with 5.78 percent a year earlier, Freddie Mac says.
But the housing market's health remains precarious as foreclosures continue to mount.
"This phaseout is significant because housing, though stabilizing, is very dependent on the government help and so much of the economy depends on housing," said Sung Won Sohn, economist at California State University's Smith School of Business.
The central bank announced the mortgage-buying program in November, after financial turmoil reached a crisis point.
The Fed has bought roughly $775 billion worth of both mortgage-backed securities and debt from Fannie Mae, Freddie Mac and Ginnie Mae, which finance most new mortgages. The central bank is buying roughly 85 percent of the mortgages issued by those companies, according to one estimate. It's basically bankrolling mortgage lending.
By doing so, the Fed is helping provide demand for these securities -- which had dried up when the crisis deepened -- and forcing down mortgage rates. The Fed's purchases of mortgage securities and debt have averaged roughly $25 billion a week over the past six weeks.
The Fed did say additional mortgage purchases could occur if economic conditions warrant.
A $8,000 federal tax credit for first-time home buyers also is helping to shore up the housing market. There's a bipartisan push on Capitol Hill to extend the credit, which expires on Nov. 30. As the recovery gains traction, the Fed will face more pressure to wind down some emergency programs. It's a fine line.
Policymakers need to leave programs intact long enough to support the recovery -- but not so long as to unleash inflation later on.
Inflation will remain in check, according to the Fed policymakers, who got rid of language in their August statement that noted rising prices for energy and other commodities.
Factories are still operating well below capacity. Other factors keeping prices in check include the weak job market -- enabling employers to avoid wage increases -- and cautious shoppers making companies wary of raising costs.
After suffering a free-fall, the economy is growing at a pace of 3 to 4 percent in the current quarter, many analysts predict. But Bernanke warned that growth in the months ahead probably won't be strong enough to generate many new jobs and prevent the unemployment rate from rising. The rate hit a 26-year high of 9.7 percent in August and is expected to top 10 percent this year.
"The U.S. economy has moved from its deathbed to intensive care, so some of the Fed's more extreme policy programs can be rolled back," said Richard Yamarone, economist at Argus Research.
"However, the patient is still in intensive care, and the central bank should be careful not to pull the plug too quickly."
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