The Federal Reserve is moving toward new steps aimed at lowering interest rates on mortgages and other kinds of long-term loans, without making another massive infusion of money into the economy.
When Fed officials hold a pivotal meeting in two weeks, they will strongly 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 for investments and push more dollars into the stock market, in addition to reducing rates on mortgages and other consumer loans.
Sept. 6 (Bloomberg) -- Randall Kroszner, professor of economics at the University of Chicago and a former Federal Reserve governor, discusses Federal Reserve monetary policy and the U.S. economy. Kroszner, speaking with Betty Liu and Thomas Lee, chief U.S. equity strategist at JPMorgan Chase, on Bloomberg Television's "In the Loop," also discusses the European financial crisis. (Source: Bloomberg)
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To pay for the bond purchases, the Fed would sell off some of the shorter-term bonds it already owns rather than printing 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. This discussion prompted wide speculation that the Fed might do it again.
But now the consensus among Fed policymakers is jelling around the new strategy. While it might avoid some of the controversy that surrounded the bond purchases, including sharp criticism by some lawmakers and Republican presidential candidates, Fed officials expect the new approach to have a similar benefit for economic growth. The Fed’s policy committee will consider this and other strategies at its meeting on Sept. 20 and 21.
The willingness of Fed officials to embark on this effort to lower interest rates reflects their serious concern about an economy that is on a knife’s edge. Economic growth has been so weak in recent months that there is risk of a vicious cycle of falling incomes and employment — unless the Fed gives the economy a nudge.
The idea of shifting the composition of bonds the Fed already owns — sometimes known as a “twist” operation — is not without downsides, however. Interest rates already are very low, and pushing them down further may not have much effect. One major aim would be to encourage people to refinance their mortgages, freeing up money to spend on other things and foster 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.
At the same time, 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,” Michael Feroli, chief North American economist for J.P. Morgan Chase, said when asked about a possible shift in the Fed’s bond portfolio. He estimated that the move would lower mortgage rates by 0.1 to 0.2 percent.
The move to change the makeup of the portfolio would probably attract internal disagreement. Already, three Fed officials dissented from a decision at the last meeting by the policymaking board meant to lift the economy by extending how long the central bank envisions keeping interest rates low.