Fed to Try Additional Unusual Methods
It Could Buy Up Long-Term Bonds

By Neil Irwin
Washington Post Staff Writer
Thursday, January 29, 2009

The Federal Reserve yesterday indicated that it will pursue further unconventional steps to try to stimulate the economy, as it left the interest rate it controls essentially at zero.

With its main tool for managing the economy spent, the Fed has been finding new ones -- and shows every indication of continuing the practice as it tries to grapple with a rapidly deteriorating economy.

The Federal Open Market Committee said it stands ready to buy up more mortgage-backed securities, could start buying long-term government bonds, and may take further steps to make loans more widely available. Those measures would push down the interest rates on loans that consumers take out to buy homes or cars or that businesses take out to buy new equipment.

"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability," the committee said in a statement released yesterday afternoon following two days of meetings.

The stock market rose on the day, as investors reacted favorably to the Fed's actions and to reports that the Obama administration could set up a "bad bank" to deal with toxic assets. The Dow Jones industrial average closed up 201 points, or 2.5 percent.

According to their statement, leaders of the central bank concluded that the economy is worsening sharply. They noted that "industrial production, housing starts, and employment have continued to decline steeply as consumers and businesses have cut back spending," and that the global economy seems to be "slowing significantly."

Indeed, the central bank even seemed to acknowledge that its forecast of a return to economic growth in the second half of 2009 may be too rosy. "The downside risks to that outlook are significant," the statement said.

"Their view of the outlook seems to be more dour and dark than it did even in December," said Stuart Hoffman, chief economist at PNC Financial Services Group.

The committee also showed heightened worry about deflation, or falling prices, saying that it sees a risk that inflation would stay too low for too long. Such concerns also indicate the Fed is inclined toward further aggressive action to pump money into the economy.

The Fed usually tries to combat economic weakness by adjusting the federal funds rate, the interest rate at which banks lend to each other, which then flows to consumers and businesses in the form of lower borrowing costs.

In December, the Fed cut that rate to a range between zero and a quarter of a percent and signaled it is likely to leave the rate there for some time. Thus, the Fed is now looking to adjust other, longer-term interest rates. It is also attempting to restart lending using its own massive balance sheet, an approach that Chairman Ben S. Bernanke has called "credit easing."

In its statement yesterday, the Fed indicated more openness to purchasing long-term government bonds, a step that should indirectly push down interest rates on mortgages and many corporate loans.

The central bank said it is "prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets." That goes further than the Fed did in December, when it said it was "evaluating the potential benefits" of such actions but did not signify that such purchases were imminent.

The Fed also noted that it is launching a special program to support credit card lending and auto loans, student loans and small business loans. It will also consider expanding that program to further improve the availability of credit.

"They're doing a little bit of everything," said Kurt Karl, chief U.S. economist at Swiss Re, the insurance firm. "They seem to be interested in what's the best way to inject more money into the economy."

There was one dissent at the meeting, with Federal Reserve Bank of Richmond President Jeffrey M. Lacker preferring to expand the money supply through purchases of Treasury bonds, as opposed to steps that push more money into specific sectors such as mortgage lending.

Shortly after the meeting, Daniel Tarullo, President Obama's appointee as the newest Fed governor, was sworn in. He was confirmed by the Senate on Tuesday.

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