What ammunition does the Fed have left?
Federal Reserve Chairman Ben Bernanke told his global central bank colleagues on Friday that the U.S. central bank still has ample means to counter slowing growth and will use it if necessary.
Speaking at the exclusive, invitation-only seminar that draws top policymakers from around the world to a resort in the shadow of the Teton mountains every year, Bernanke conceded the U.S. recovery has lost more steam than had been expected.
But he said options exist to deal with that.
"The committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly," Bernanke said in a keynote address.
Essentially, the Fed chief was reiterating some of what he had told Congress in July, when he said the central bank could bolster its language committing to hold interest rates low for an extended period, lower the rate it pays on the reserves banks hold at the Fed and either stop letting securities run off of its balance sheet or make additional asset purchases.
No decisions have been taken about more easing, nor even what specifically might make the Fed do so, Bernanke said.
"At this juncture, the committee has not agreed on specific criteria or triggers for further action," he said.
The Fed has already acted, on August 10, to hold mortgage-related assets steady on its balance sheet by using cash from maturing bonds it holds to buy more government debt, thus adding liquidity to the financial system.
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 home buying and push additional credit into the economy for banks to lend.
It has stopped purchases and was letting the portfolio diminish as securities matured or were prepaid but now is reinvesting the money in mortgage-linked debt.
Among other steps the Fed could undertake are the following.
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 in Arkansas earlier this month that the Fed might need to ramp up its purchases of U.S. Treasury debt if price levels keep softening and raise the threat of deflation.
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 a 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, Bernanke might find it hard to garner support for such a move. A number of Fed officials have expressed concern 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 unsated 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.
[Source: Reuters, Jackson Hole, Wyoming, 24Aug10]
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