The Fed’s toolkit: depleted but not empty

August 4, 2011

A sharp slowdown in U.S. growth has raised speculation the Federal Reserve may have to provide additional monetary support to the economy. With interest rates already effectively zero and the Fed’s balance sheet at a record $2.85 trillion, U.S. central bank officials are reluctant to take further steps to stimulate economic activity. Still, persistent unemployment and fresh turbulence in financial markets could boost the pressure on the Fed to do something. No concrete action is expected at an upcoming meeting on Tuesday, but officials could acknowledge growth forecasts made in June now look overly optimistic.

The bank’s policy arsenal is depleted but not completely empty. Fed Chairman Ben Bernanke testified last month that the Fed was prepared to respond to possible further weakness. Here are some of the measures he said are still available to the Fed:

BOLSTER EASY POLICY ASSURANCES

The Fed has already promised to hold benchmark interest rates extraordinarily low for an extended period. It could bolster that commitment by extending the pledge to the securities holdings acquired through unconventional monetary policy. Or it could pledge to hold rates near zero until a specific date beyond the timeframe currently expected by markets.

BOND BUYS

New purchases of long-term Treasury assets is seen as a possibility. The Fed believes its two rounds of bond-buying have held longer-term rates down and encouraged investors to move into riskier assets, helping drive the stock market higher. The Fed could also increase the average maturity of its securities holdings to put further downward pressure on long-term borrowing costs.

LOWER THE INTEREST RATE ON EXCESS BANK RESERVES

The Fed could lower the 0.25 percent interest rate it currently pays banks on excess reserves held at the Fed. Doing so could encourage banks to put those reserves to use by lending them out. But Bernanke has said the likely impact of moving this already low rate even lower would be marginal.

RAISE THE FED’S INFLATION TARGET

By temporarily setting a target for inflation above what the Fed considers consistent with long-term price stability, the Fed would again be communicating to markets that any tightening of monetary policy is far off. However, Bernanke has made clear this was a highly controversial proposition within the Fed and is an unlikely course of action. He did not mention this possibility in his most recent remarks on possible easing tools.

 

3 comments

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The Fed’s toolkit IS virtually empty if you consider the very real possibility of a financial cave-in in Europe and shockwaves spreading to the U.S., resulting in another financial cave-in here too.

This time it will be much worse than in 2008 – there won’t be trillions of dollars for any bailouts, and U.S. sovereign debt itself will very likely get smacked as investors realize piling into Treasuries was the wrong move. The Fear: As the U.S. financial sector begins to cave in and as the country plunges into another recession, how safe is U.S. sovereign debt??? Will the U.S. have no choice but to do selective default as its finances crumble???

It’s time to consider this scenario, whose chances of coming true are rapidly rising in an unfolding perfect storm that now imminently threatens to engulf both Europe and the U.S.

Posted by NukerDoggie | Report as abusive

Dear Mr. da Costa, what does a nation do when it has no money to pay its bills ? When real growth is lacking ?When all other instruments have failed ?

The Fed will print, print, print.

Hundreds upon hundreds of billions fresh dollar bills, electronically or physically will enter the market. The machines are still warm from QE2.

Posted by FBreughel1 | Report as abusive

The problem isn’t that the Fed doesn’t have any more levers with which to move the economy. The problem is, both the Fed and the Obama Administration have been simply band-aiding all the economic problems while they waited for the consumer to spend us out of this recession.

Guess what. Ain’t gonna happen. Perhaps once the Fed, the Administration, Congress, even the EU, get their heads wrapped around the idea that this time the consumer is NOT going to lead the way out of the economic quagmire, we will see some concrete action on the economic front.

Maybe.

Posted by stanrich | Report as abusive