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Federal Reserve to unveil new stimulus effort

Text by News Wires

Latest update : 2010-11-03

The US Federal Reserve is expected to announce on Wednesday plans to pump up to 500 millions dollars into the economy in order to push down borrowing costs for consumers and businesses and back up the fragile recovery.

REUTERS - The Federal Reserve is expected to announce a controversial new policy on Wednesday to buy billions of dollars in government bonds in an attempt to breathe new life into the struggling U.S. economy.

The well-telegraphed decision would be aimed at pushing down borrowing costs for consumers and businesses still smarting from the worst recession since the Great Depression, though there are doubts about its effectiveness.

With the U.S. economy expanding at only a 2 percent annual pace in the third quarter and the jobless rate seemingly stuck around 9.6 percent, the Fed has come under pressure to do more to stimulate business activity.

Economists expect a new round of Treasury purchases to total about $500 billion over a six-month period and to be accompanied by a signal that officials, who have been divided over the wisdom of the move, might ramp up the operation if needed.

"We expect the statement will express a willingness -- but not necessarily a bias -- to further increase asset purchases if warranted by economic conditions," said Michael Feroli, chief U.S. economist at JPMorgan in New York.

The Fed is expected to announce its decision at around 2:15 p.m. (1815 GMT).

Policy made in USA for USA

Markets have already seen sharp moves in anticipation of the Fed's expected resumption of bond purchases, which were first undertaken as a response to the financial crisis of 2007-2009. U.S. stocks and government bonds have rallied, while the dollar has taken a drubbing in advance of the decision.

Stocks have also been supported by expectations -- now validated -- that Republicans, viewed as more pro-business by investors, would seize control of the House of Representatives and pick up Senate seats in elections on Tuesday that were largely cast as a referendum on the economy.

As Republicans campaigned on a smaller government platform, Congress may be less likely to offer fresh stimulus spending if the economy sputters, leaving the Fed as the primary source of support.

The Fed cut overnight interest rates to near zero in December 2008 and has already bought about $1.7 trillion in U.S. government debt and mortgage-linked bonds.

With the prospect of a long period of ultra-low returns in the United States, investors have flocked to emerging markets, pushing those currencies higher. Emerging economies, worried about a loss of export competitiveness, have cried foul.

"We are all under attack by the relaxed monetary policy of the United States," Colombian Finance Minister Juan Carlos Echeverry told investors on Tuesday.

The Bank of Japan, which meets on Thursday and Friday, is also poised to launch a new round of bond buying. The European Central Bank and Bank of England also meet this week, but are not expected to make any changes to policy for the time being.

Debating the risks

As things now stand, the U.S. economy is not growing quickly enough to put a dent in the unemployment rate.

With 14.8 million Americans unemployed and factories operating well short of full capacity, some Fed officials see the risk of a vicious circle where consumers hold off on purchases in hopes that prices will fall, choking off economic growth.

Inflation is well below the Fed's preferred range of between 1.7 percent and 2 percent. In the third quarter, core inflation, which strips out volatile food and energy prices to give a better view of the underlying trend, rose at a 0.8 percent annual rate, the second-slowest pace since 1962.

Bernanke laid the groundwork for a further round of bond purchases by arguing the central bank was falling short of its twin objectives -- price stability and full employment.

Further bond purchases, however, are viewed with a skeptical eye by many members of the Fed, and heated debate is expected.

The Fed owns roughly 12.5 percent of all outstanding Treasury bonds and notes. If it were to buy $1 trillion more, as some economists expect it eventually will, the portion of its holdings compared with all outstanding Treasuries could jump to 27 percent.

Some economists, and some Fed policymakers, worry further purchases could jeopardize the central bank's credibility if the impact proves small. There are also concerns the Fed's bloated balance sheet may set the stage for rampant inflation once the recovery gains traction.

Kansas City Fed President Thomas Hoenig, who is concerned the Fed's easy money policies are prelude to yet another boom and bust cycle, said on Oct. 25 that further easing would be "a bargain ... with the devil."

 

Date created : 2010-11-03

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