The Federal Reserve took a dramatic step Wednesday to help revive the economy, resuming its unconventional efforts at stimulating growth nearly a year after embarking on an initiative that ultimately failed to deliver a healthy recovery.
The Fed’s latest move aims to lower interest rates on mortgages and other long-term loans without making another major infusion of money into the economy — and brushes aside a crescendo of criticism from Republicans who have been making the Fed a campaign issue.
An explanation of how the Fed’s action could affect the economy.
Federal Reserve policy makers will replace some bonds in their portfolio with longer-term Treasuries in an effort to further reduce borrowing costs and keep the economy from relapsing into a recession. (Sept. 21)
Why Fed’s announcement isn’t a game changer
The announcement that the Fed would buy $400 billion in long-term Treasury bonds immediately achieved its intended effect, pushing rates on these securities and other investments to their lowest level in decades.
But the stock market rendered a sharply negative verdict. The Standard & Poor’s 500-stock index tumbled almost 3 percent on the Fed’s discouraging statement that its leaders see “significant downside risks” for the economy. Asian markets closed down between 2 and 4.85 percent, and key European indexes were trading more than 4 percent lower at midday.
“They succeeded at getting lower long-term interest rates, but the confidence they wanted to encourage didn’t seem to come through,” said Jim O’Sullivan, chief economist at MF Global. “That has to be disappointing.”
In deciding to put their foot back on the pedal, Fed officials rebuffed calls from Republican congressional leaders, in a letter sent Monday to Fed Chairman Ben S. Bernanke, that the central bank refrain from taking new steps to spur growth, fearing they could actually harm the economy. There was also opposition inside the Fed’s policymaking board, with three members dissenting from the decision.
The Fed action, which capped a two-day meeting, is focused squarely on lowering mortgage rates in an effort to strengthen the ailing housing market and lighten the load of the tremendous debt weighing on consumers. The move could also make it cheaper for businesses to borrow money for investments and push more dollars into the stock market.
The program of buying long-term Treasury bonds will continue through June. Instead of paying for the bonds with newly created money, as the Fed did during a $600 billion program that ended three months ago, the central bank will use proceeds from selling off $400 billion in shorter-term securities on its books.
The bond-buying program that ended in the summer, though massive in scale, failed to keep economic growth from sputtering. The disappointing result showed the limits of what the Fed can accomplish at a time when consumers are struggling with enormous debts and the U.S. banking system remains traumatized. The new initiative could face the same constraints.
The Fed’s strategy is often called a “twist” operation because it simultaneously pushes long-term rates downward and short-term rates upward. And that is exactly what happened in financial markets after the announcement. The interest rate on 30-year Treasury bonds fell two-tenths of a percentage point to drop below 3 percent for the first time since records were kept.