Markets watch as Fed opens meeting

September 19, 2011

As the Federal Reserve begins a two-day meeting Tuesday, the backdrop is drearily familiar: Job growth in the United States faltering, the outlook increasingly hazy, the world economy at risk.

And once again, the eyes of the world will be on Chairman Ben S. Bernanke and his colleagues to see if they can come up with any more steps to boost growth and avert a slide back into recession. They will likely discuss a range of possibilities, from a subtle shift in the Fed’s bond holdings to a rethinking of how the central bank communicates to markets and the public about its intentions.

The decision will be yet another big test for Bernanke and the Fed. The central bank will look to make a move that will solidify growth even as previous measures seem to have had little economic impact, and do so without causing a troublesome outbreak of inflation.

“Given the weakness of the incoming economic data, the Fed is now almost certain to do something, but exactly what is still not entirely clear,” said Paul Ashworth, an economist at Capital Economics.

The Fed’s target for short-term interest rates has been near zero for almost three years, and at the last policy meeting leaders of the Fed’s member banks said they expect economic conditions to warrant keeping rates there through at least 2013. In June, the Fed completed a program of buying $600 billion in bonds to further pump money into the economy.

One possibility would be to announce another round of so-called quantitative easing, which aims to reduce long-term interest rates and push up the value of other financial assets. But there is significant resistance to that strategy within the Fed, a sense that it would be better to try to ease monetary policy without injecting newly created money into the economy.

A possibility that many Fed officials seem to favor would be to shift the Fed’s holdings of Treasury bonds into securities that mature in the more distant future. In effect, this step would allow the Fed to put downward pressure on mortgage rates and corporate borrowing costs without adding to its total holdings.

A more dramatic possibility that has emerged would be to lay out specific targets for unemployment and inflation, and indicate that low-interest-rate policies will remain in place until one of those targets is breached. Chicago Fed President Charles Evans has been the most vocal proponent of that approach, arguing that the central bank should pledge to keep easy money in place until either unemployment sinks below 7.5 percent from its current 9.1 percent or inflation rises above 3 percent.

“As I see it, current financial conditions are more restrictive than I favor, because households, businesses and markets place too much weight on the possibility that Fed policy will turn restrictive in the near to medium term,” Evans said in a Sept. 7 speech.

That approach, while likely to be discussed at this week’s meeting, may be a step too far for many on the policy committee. The Fed has long aimed for 2 percent inflation, and Evans’s approach would essentially mean temporarily increasing that target, announcing the Fed would tolerate somewhat higher inflation in the short term to bring unemployment down.

That conflicts with how many central bankers view their role. For example, former Fed chairman Paul Volcker came out against the idea in an opinion article Monday, writing in the New York Times that “experience confirms that price stability — and the expectation of that stability — is a key element in keeping interest rates low and sustaining a strong, expanding, fully employed economy.”

If the Federal Open Market Committee does take a new measure to ease policy, there is a strong possibility of further dissent. Three officials dissented from the Fed's August decision to indicate it expects to keep rates low for two more years.

This is a two-day meeting, compared to August’s single day, which will allow Bernanke more time to try to guide the committee toward consensus.

But Bernanke has shown that he is willing to undertake actions that attract dissenters, and the consensus of the policy committee appears to have shifted over the past couple of months toward focusing on what steps the Fed might take to reduce unemployment.

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