By Neil Irwin
Washington Post Staff Writer
Tuesday, January 27, 2009
When Federal Reserve policymakers begin a two-day meeting today, they will be starting a new era in American monetary policy.
Normally at meetings of the Federal Open Market Committee, the big announcement at the end is whether the central bank has decided to raise short term interest rates or lower them.
But the Fed has pushed the federal funds rate, a bank lending rate it controls, effectively to zero, and indicated that it will likely leave it there for some time. That has exhausted the central bank's primary policymaking tool, meaning its leaders will use less conventional methods to bolster the rapidly worsening economy.
"They're in uncharted territory," said Diane Swonk, chief economist at Mesirow Financial.
At its Dec. 16 policymaking meeting, the Fed laid out a new framework for its stewardship of the economy, suggesting the way it might try to stimulate growth. When the Fed releases its statement at 2:15 p.m. tomorrow, following the meeting's conclusion, Fed watchers will see what that means in practice.
The Fed could expand a program to buy up mortgage-related securities, a plan that already has pushed mortgage rates down sharply. Under that program, announced just before Thanksgiving, the central bank has agreed to buy up to $100 billion of debt in housing finance companies Fannie Mae and Freddie Mac and $500 billion of mortgage-backed securities issued by the companies.
As of last week, the Fed had only closed on about $30 billion of those purchases, yet even that was enough to push the average rate on a 30-year fixed-rate mortgage down to 5.1 percent last week, compared with 6.1 percent in November.
Fed leaders were surprised that the relatively small amount of purchases was enough to lower borrowing rates, which serve to stimulate the economy as homeowners refinance their mortgages to have more money to spend on other goods and more people buy homes to take advantage of the low rates.
It also could expand a program, also announced in November and poised to begin in February, that would use $200 billion in Fed resources to support lending through credit cards or for car loans, student loans, and small business loans.
"The Fed wants to bring down the rates facing households and firms," said Peter Hooper, chief economist at Deutsche Bank Securities. "This is the program that could have the most traction."
On the other hand, Fed leaders may be reluctant to expand the consumer-lending program before it has begun functioning. The transition to the Obama administration may also make it harder to quickly change the program, which is a joint effort with the Treasury Department.
A third option the Fed may move on this week would be to start buying long-term Treasury bonds to try to push down interest rates on all kinds of longer-term borrowing. Normally the Fed manipulates interest rates only by buying up short-term Treasury bills. But if it bought five- or 10-year bonds, it could help lower borrowing costs for companies and individuals that borrow money for long periods of time.
There may be reason for Fed officials to be cautious about buying long-term debt, however. Yields on such Treasury bonds are already near historic lows, with the government able to borrow money for 10 years at 2.6 percent. Moreover, with credit markets not working normally, there can be little certainty that pushing those rates even lower would result in savings for private borrowers.
While the central bank won't necessarily make announcements in all these areas this week, analysts said, all are options in the months ahead. Moreover, the Fed can impact markets merely by discussing its intentions to undertake new lending, even in advance of it happening.
"Do you want the policy initiatives you're taking to be more targeted at unraveling the credit market seizures or better for overall rates?" Swonk asked. "The answer is the Fed has to do a little bit of everything."