Tags: Fed | Bullets | Economy | ben | bernanke

Fed Still Has Some Tactics Left to Try and Revive Economy

Monday, 19 Jul 2010 02:52 PM


Federal Reserve Chairman Ben Bernanke will deliver his semi-annual testimony to the U.S. Congress this week, and investors are keen to find out just how open he is to the possibility of further monetary easing.

Minutes of the Fed's June meeting, released last week, showed the U.S. central bank debated what steps it might take if the economy were to weaken much further.

The Fed has already slashed interest rates to near zero, promised to hold them there for extended period, and flooded the economy with more than $1 trillion in additional credit to get things going.

What ammunition does the Fed have left?

Hold Mortgage-Related Asset Levels Steady on Balance Sheet

To ease the 2007-2009 financial crisis, the Fed bought about $1.3 trillion in mortgage-backed securities and debt issued by government-sponsored mortgage finance enterprises to lower mortgage rates, stimulate homebuying and push additional credit into the economy for banks to lend.

It has stopped purchases and is letting the portfolio diminish as securities mature or are prepaid.

It could instead resume buying these securities to maintain a steady level of ownership.

This approach would likely yield its greatest impact upon being announced, signaling Fed angst about the recovery.

But it may not produce much of an effect on housing markets with mortgage interest rates already at rock-bottom.

Buy More Assets

The Fed could buy more mortgage-backed securities, or since its holdings of MBS are already so large, it could buy more long-term Treasury securities.

St. Louis Fed President James Bullard said recently that further purchases of long-term Treasuries would be the most likely path if the economy took a decisive turn for the worse.

Moving to buy more assets only months after declaring its buying spree over would be a risky flip-flop for the Fed, which tries to be as steady and predictable as possible. Dallas Fed chief Richard Fisher on Wednesday voiced concerns such a move could dent the central bank's credibility.

Buying Treasuries could raise questions about whether the Fed is simply printing money to finance the massive U.S. budget deficit and debt, which could undermine confidence in the dollar and drive interest rates higher.

Deepen Its Commitment to Hold Rates Low for Long Time

Since March 2009, the Fed has said it anticipates that economic conditions are likely to warrant "exceptionally low" borrowing costs for "an extended period." It has specified that those conditions include high unemployment, subdued inflation trends and stable inflation expectations.

The Fed could rephrase that promise to provide additional guarantees to markets of rock-bottom rates even when the recovery begins to take off.

However, Fed Chairman Ben Bernanke might find it hard to garner support for such a move. A number of Fed officials have expressed concerns that the low-rate pledge could hinder the central bank from acting quickly if needed.

Stop Paying Interest on Excess Reserves

The Fed could try to spark more lending by cutting the interest rate it pays banks on reserves they hold at the central bank from the current 0.25 percent. This would only be effective if there was unsatiated loan demand, which some doubt.

Open a New Lending Facility

The Fed could open or keep open a lending facility to increase credit availability for any sector of the economy it wants to help, such as commercial real estate.

The Fed would have to argue that crisis conditions exist in order to lend to non-banks, and may be shy about doing so after similar actions were criticized during the 2007-2009 financial crisis.

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