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Fed is exploring new ways to give economy a nudge

The Fed’s chief, Ben Bernanke, stresses that the Fed compares the cost of policy steps, such as risk of inflation, to the benefits. The Fed’s chief, Ben Bernanke, stresses that the Fed compares the cost of policy steps, such as risk of inflation, to the benefits.
By Neil Irwin
Washington Post / September 8, 2011

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WASHINGTON - The Federal Reserve is moving toward new steps aimed at lowering interest rates on mortgages and other long-term loans, without making another massive infusion of money into the economy.

When Fed officials meet in two weeks, they will consider buying more long-term Treasury bonds, which should lead to lower interest rates for those bonds and other long-term investments. This would ultimately make it cheaper for businesses to borrow money and push more dollars into the stock market, in addition to reducing rates on consumer loans.

To fund bond purchases, the Fed would sell off some of the shorter-term bonds it owns, rather than print new money.

At their last meeting, Fed officials discussed whether to revive their earlier program of massive bond purchases, using newly printed money to buy hundreds of billions of dollars in securities as a way of pumping money into the economy. That prompted wide speculation the Fed might do it again.

But now the consensus among policy makers is gelling around the new strategy. While it might avoid some of the controversy that surrounded the bond purchases, Fed officials expect the new approach to have a similar benefit. The Fed’s policy committee will consider this and other strategies Sept. 20-21.

Economic growth has been so weak in recent months that there is risk of a cycle of falling incomes and employment, unless the Fed nudges the economy.

Shifting the composition of bonds the Fed already owns, sometimes known as a “twist’’ operation, is not without downsides, however. Interest rates are very low, and pushing them down further may not have much effect. One major aim would be to encourage people to refinance mortgages, freeing up money to spend on other things and fostering economic activity. But with so many people owing more on their homes than the homes are worth, relatively few are in a position to take advantage of lower rates to refinance.

And by shifting from short-term bonds to longer-term ones, the Fed would face a greater risk of losing money when it is time to sell them. Just as for an individual investor, a 30-year bond is a riskier investment for the Fed than a two-year bond.

“It’s not going to change this into a smoking recovery, but at least it will be pushing things in the right direction,’’ said Michael Feroli, chief North American economist for J.P. Morgan Chase. He estimated the move would lower mortgage rates by 0.1 to 0.2 percent.

A move to change the makeup of the portfolio would probably stir disagreement. At the last meeting, three Fed officials dissented from a decision that was meant to lift the economy by extending how long the central bank envisions keeping interest rates low.

At the upcoming meeting, Fed officials are likely to take up other possible measures. These could include pledging to keep the overall size of the bond holdings intact for a long period and detailing the specific conditions under which the Fed would begin scaling back its efforts.

The Chicago Fed’s president, Charles Evans, has called for keeping low rates until the jobless rate falls to 7 percent or inflation rises above 3 percent. Many of his colleagues would probably chafe at his inflation target.

Chairman Ben Bernanke has repeatedly said the Fed compares the cost of policy steps, such as risk of inflation, to the benefits. A better-functioning mortgage market, according to a growing consensus at the Fed, could increase the benefits of new action without increasing the costs.