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Fed aims to revive US economy without traditional tools

Latest update : 2009-03-18

The Federal Reserve concludes a two-day meeting Wednesday with an eye on further efforts to revive the ailing US economy without being able to use its traditional tool of interest rate policy.

AFP - The Federal Reserve concludes a two-day meeting Wednesday with an eye on further efforts to revive the ailing US economy without being able to use its traditional tool of interest rate policy.

The Federal Open Market Committee (FOMC), which began deliberations at 1800 GMT Tuesday, was expected to leave unchanged its base lending rates at zero to 0.25 percent as it mulls further moves to tackle the credit crunch and economic slump.

An announcement by the FOMC was expected around 1815 GMT Wednesday.

With the traditional tool of interest rate policy now exhausted, the central bank is focused on extraordinary efforts to pump up credit to boost the economy.

It has already started buying up mortgage securities and corporate commercial paper, and is set to launch a new program to pump 200 billion dollars into consumer credit through the purchase of securities linked to auto, student and other types of loans.

These moves expand the central bank's balance sheet, essentially by printing money in an effort to keep credit flowing.

Fed chairman Ben Bernanke calls this "credit easing," saying it is aimed at stimulating borrowing and thus different from "quantitative easing" used in the 1990s in Japan and now mulled by other central banks.

The Fed is likely to keep open the option of buying long-term US Treasury bonds -- which some analysts say would be an example of quantitative easing -- if needed to help bring down overall borrowing costs.

Economist Ed McKelvey at Goldman Sachs said the Fed might not be ready to take the dramatic step of intervening in the Treasury market.

Although some data including unemployment show conditions worsening, McKelvey said there are positive signs, which might keep the Fed on hold.

"The data on consumer spending have been encouraging, especially the latest figures," he said.

Additionally, he noted that "financial conditions have turned for the better in the last week and Fed rhetoric has been less supportive of the Treasury purchase option in recent weeks than it was before the January meeting."

Still he said debate will be heated and that the Fed could follow the lead of the Bank of England in an effort to pump in as much stimulus into the economy as it can.

"The amount of Fed balance-sheet expansion needed to provide 'sufficient' easing in monetary policy is massive," he said.

McKelvey said the Fed still must be on guard against a potentially crippling deflationary spiral and that to do so it needs "to use all options available to increase the size of its balance sheet sharply."

Robert Brusca at FAO Economics said that instead of buying Treasuries, the Fed will likely concentrate on specific areas of credit where it would like to bring down rates.

"Academic studies suggest that the Fed will have a hard time imposing any meaningful impact on long-term Treasury yields by simply purchasing long-term Treasury paper," Brusca said.

Brusca said buying Treasuries is "not a good idea."

"In fiddling with the yield curve the Fed is playing with fire," he said.

"There is little reason to think that such interventions could be powerfully effective and many more reasons to think that the Fed could get itself in trouble with such an operation. Given the importance of long-term rates to international investors, I would worry about some impact on US capital flows, too."

Date created : 2009-03-18