By MARTIN CRUTSINGER
When the Federal Reserve holds a policy meeting Tuesday and Wednesday, it's
widely expected to adopt some new step to boost the economy. The question is
what it will be.
Whatever the Fed does will likely be intended to drive down long-term
interest rates to encourage borrowing and spending and lift stock prices. The
idea is that all of that would combine to help raise economic growth and
hiring.
The move that's considered most likely is for the Fed to adjust the makeup of
its $1.7 trillion portfolio of Treasury securities. The Fed would sell some
shorter-term Treasurys. And it would use the proceeds to buy longer-term
Treasurys. That shift could drive down long-term rates, which affect rates on
mortgages and other loans.
The central bank is weighing unusual steps because the economy is struggling
to grow, and the Fed's main policy lever, the federal funds rate, is already
near zero. The funds rate is the rate banks charge each other on overnight
loans,
Investors have been anticipating action out of this week's meeting, in part
because Chairman Ben Bernanke said in August that the September policy meeting
would take two days, rather than one, to give Fed members more time to discuss
their options.
"If they weren't going to do anything, then I think they would have tried to
deflate expectations by now," said David Wyss, former chief economist at
Standard & Poor's and now a visiting fellow at Brown University.
Here's a look at the Fed's options:
• ADJUSTING ITS PORTFOLIO
This is the move that most analysts expect to be announced when the Fed's
meeting ends Wednesday. It's been dubbed "Operation Twist," after a similar move
taken in the early 1960s when Chubby Checker's version of "The Twist" was the
rage. The Fed tried to "twist" rates to lower long-term rates relative to
short-term rates.
Anticipation that the Fed will adopt some form of Operation Twist, combined
with sour economic news, has helped push down the rate on the 10-year Treasury
note to 1.95 percent. In July, the rate exceeded 3 percent.
Some economists think such action could lower the 10-year rate by an
additional quarter-point. On the other hand, should the Fed decide not to take
this step, long-term rates might head higher.
Operation Twist has the advantage of potentially lowering long-term rates
without expanding the Fed's already record-high portfolio of securities. The Fed
will eventually need to shrink its portfolio.
Still, critics caution that by lengthening the average maturities of its
holdings, the Fed might make it harder to wind down its portfolio without
pushing rates up again.
• MORE BOND PURCHASES
The Fed could announce a third round of bond buying, a step known as
quantitative easing. This would probably be the most dramatic move it could
make. Economists think it's unlikely, in part because of heavy criticism the
second round of bond buying evoked from some. Critics warned that the purchases
raised the threat of inflation, weakened the dollar's value and contributed to a
spike in prices of oil and other commodities.
Republican presidential candidate Gov. Rick Perry of Texas has said it would
be "almost treasonous" for Bernanke to launch more bond buying.
On Aug. 9, the Fed said it planned to keep short-term rates at record lows
until at least mid-2013, assuming the economy remained weak. That statement drew
three dissenting votes inside the Fed — the most in more than two decades.
Bernanke could face even stiffer resistance to a new bond-buying program.
• WORDING CHANGE
The Fed could provide further guidance on future action. Such a move is being
urged by Charles Evans, president of the Federal Reserve Bank of Chicago.
Evans has suggested that the Fed commit to keeping rates low until
unemployment, now 9.1 percent, drops to 7.5 percent or lower — as long as "core"
inflation doesn't exceed 3 percent. Core inflation excludes volatile food and
energy prices.
That commitment could reassure investors that rates would remain low well
into the future. But this idea would likely ignite opposition from some Fed
regional bank presidents who worry that Fed policies have already raised the
risk of high inflation once the economy gains momentum.
• INTEREST ON RESERVES
Another option Bernanke raised in testimony to Congress in July was to reduce
the 0.25 percent interest the Fed pays banks on their excess reserves. The
thinking is that cutting that rate would reduce the incentive for banks to keep
their money at the Fed. So they might lend more.
Yet economists say the availability of credit isn't the main reason for low
levels of lending. Rather, it's weak consumer and business confidence, which has
cut demand for loans. They say that reducing the already tiny interest rate on
banks' reserves would have a negligible effect on lending.
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