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Fed set to give economy therapy, not shock treatment

Sep 14, 2011, 4:56 a.m.
Chairman of the Federal Reserve Ben Bernanke reacts while testifying before the Senate Banking, Housing and Urban Affairs Committee about "The Semiannual Monetary Policy Report to the Congress" on Capitol Hill in Washington, July 14, 2011. REUTERS/Larry Downing

However, Fed officials are sharply divided over the need for more action. Any easing, including the smaller step of reweighing the portfolio, is likely to draw three dissents, as did the Fed's August 9 decision to say it expected to hold interest rates ultra-low at least until the middle of 2013.

While Bernanke would probably like to show the greatest possible Fed unity for any action, analysts do not see the prospect of dissents as an impediment to action.

TWIST OF FATE

The move to buy longer-dated government debt has a history: Operation Twist, which ran from 1960 to 1965. That program was an effort to both tackle a recession and shrink a lingering trade deficit but was not an effort to expand monetary policy.

Fed officials will have to decide how bold they will be with Twist II. A modest approach would be for the Fed to simply replace maturing securities with longer-term ones. An alternative approach would have the Fed actively selling short-term securities to buy longer-dated debt.

Because the roll-off of assets from the Fed's balance sheet is variable and depends on mortgage markets, some analysts think the Fed will opt for sales and purchases to provide regularity and predictability.

"They would want to announce a specific schedule," said Alan Levenson, chief economist for T. Rowe Price.

The more dramatic step of buying more bonds outright, while likely to be criticized for risking inflation, cannot be ruled out entirely either.

"You wouldn't want to do that until you're so desperate you need to do something big," said Eric Green of TD Securities. A full-blown debt default crisis in Europe might be just such a catalyst, he said.

(Editing by James Dalgleish)

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