Tags: Fed | Economy | bernanke | easing

Five Possible Steps the Fed Could Take to Jolt Economy

Wednesday, 12 Sep 2012 06:49 PM

 

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Federal Reserve Chairman Ben Bernanke has made plain that the U.S. central bank is seriously considering additional monetary policy easing at its meeting on Wednesday and Thursday to help counter the "grave" stagnation of the U.S. labor market.

The policy-setting Federal Open Market Committee is expected to announce its decision at around 12:30 p.m. (1630 GMT) on Thursday and Bernanke will follow with a news conference at 2:15 p.m. (1815 GMT).

The Fed will also release policymakers' quarterly economic and interest rate projections.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

Here is an overview of what steps the Fed is weighing:

EXTENDING FORWARD GUIDANCE

Viewed as the most likely measure to be announced next week, Fed officials could extend into 2015 the so-called forward guidance they offer financial markets on how long they expect to keep overnight interest rates between zero and 0.25 percent.

The Fed currently projects that they will stay there at least through late 2014, and minutes of their last meeting showed that extending the guidance had been discussed. Interestingly, the minutes of the July 31-Aug. 1 meeting also said the message might be underscored by an additional statement that an ultra-low rates policy might be maintained "even as the recovery progresses."

The idea would be to try to ensure households and businesses don't pause spending in anticipation of higher interest rates as soon as the economy begins to gather steam. A few Fed officials also argued for making the forward-looking guidance more conditional on economic factors, rather than linked to a date in the calendar. That additional flexibility might help persuade some of the hawks to go along with the change.

MORE BOND BUYING

Less certain but probably more exciting for financial markets, the Fed could announce a third round of bond buying, or quantitative easing, on top of the $2.3 trillion in Treasury and mortgage-backed bond purchases it has already made.

Analysts are split on whether QE3 will get the nod next week, but reckon it is a top option in the coming months, unless there is a clear improvement in the U.S. economy.

Bernanke laid out a detailed defense of large-scale asset purchases in his remarks in Jackson Hole, Wyoming, on Friday and said the Fed would deploy them again if the economy warranted.

The chairman explained why he thought the benefits of QE outweighed the costs; argued that the first two rounds of QE had lowered interest rates and perhaps lifted employment by two million jobs; and concluded by warning that stagnation in the U.S. labor market was a "grave concern."

If the Fed conducts further bond buying, a key question will be the split in its purchases between U.S. government debt and mortgage-backed securities. So far, the Fed has bought $1.4 trillion of mortgage and agency debt and $900 billion in Treasuries.

The Fed may also tweak the purchase schedule to make it more flexible to allow adjustments that take account of changes in economic developments. So instead of saying up-front that it would buy a certain amount of bonds over the next six months or year, it might announce a relatively smaller amount over a shorter period and revisit the decision at following meetings.

INTEREST ON RESERVES

Another topic that may come up during the discussion next week is the interest rate the Fed pays on excess bank reserves held at the central bank. Reducing the rate — or even charging a negative interest rate to make banks pay for the security of parking spare funds with the Fed — could encourage banks to increase lending.

Fed officials said at their last meeting they would watch the experience of the European Central Bank, which has already cut this rate to zero, for clues on how well the strategy works.

Bernanke did not highlight this option last week and economists think it's on the back-burner.

FUNDING FOR LENDING

Fed officials are also intrigued by the so-called Funding for Lending scheme developed by the Bank of England and British Treasury to provide banks with an incentive to lift their lending to the private sector. However, it is also thought to be on the Fed's back-burner, in part because of major differences between the banking industries in the United States and Britain. There are hundreds of U.S. banks but only a handful of dominant British lenders.

CONSENSUS FED ESTIMATES

In another interesting sidebar to the meeting, officials will receive a second update on efforts to construct a consensus estimate of Fed policymakers' forecasts for the economy and future monetary policy. This is not something they will do any time soon, but it has the potential of capturing the policymaking committee's 'center of gravity' — which the chairman will have to own and explain — thereby reducing uncertainty on where the Fed stands.

This can sometimes be hard to figure out. The committee numbers 17 members, and currently they each provide individual forecasts, which can make it hard to locate where the committee is actually heading.

Fed watchers will get their own update on where this effort stands when the central bank releases minutes from this meeting three weeks later.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

© 2014 Thomson/Reuters. All rights reserved.

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