Fed to buy $600 billion in bonds in effort to boost economic recovery
Thursday, November 4, 2010; 12:31 AM
The Federal Reserve escalated its efforts to get the U.S. economic recovery back on track Wednesday, again entering the realm of risky and untested policy in response to the worst downturn in generations.
The plan to pump $600 billion into the financial system is designed to stimulate the economy in large part by lowering mortgage and other interest rates.
Although the approach carries significant risks for both the economy and the central bank's credibility, the steps announced by Fed policymakers could represent the nation's best hope for breaking free of sluggish growth, especially with bold initiatives unlikely from a newly divided Congress.
Fed officials concluded that growth is too slow to bring down the 9.6 percent unemployment rate and is at risk of staying that way for some time absent new action. They were also concerned that inflation has been running too low and were looking for a way to encourage modest price increases, which would give consumers and businesses more reason to spend money before its value declined and help energize the economy.
"The pace of recovery in output and employment continues to be slow," the Fed's policymaking panel, the Federal Open Market Committee, said in a statement. "Employers remain reluctant to add to payrolls. Housing starts continue to be depressed."
The Fed usually manages the economy by adjusting short-term interest rates. With those rates already near zero, Fed officials had to dust off a strategy for boosting the economy that debuted during the darkest days of the financial crisis. The Fed plans to create money, essentially out of thin air, and then pump it into the economy by buying Treasury bonds on the open market. These purchases are to be finished by the end of June, the Fed said.
Using this technique, called "quantitative easing," the Fed bought more than $1.7 trillion in securities during the financial crisis and in its immediate aftermath. The central bank's holdings jumped to their current level of $2.3 trillion, and the figure will approach $3 trillion when the new purchases are complete. This new wave of bond buying is a dramatic turnabout for an institution that just six months ago, amid a false spring in the economy, was weighing how it would begin unloading all the securities it had purchased.
The Fed action, which is aimed in part at making it cheaper for Americans to take out mortgages and for businesses to borrow money to expand, influenced the market even before the steps were formally unveiled. Average mortgage rates had already fallen from 4.5 percent for a 30-year fixed-rate loan over the summer, when Fed officials first said they were considering new steps, to 4.2 percent last week.
The stock market, meanwhile, moved higher and the value of the dollar declined over the past two months in anticipation of the central bank's action.
"This approach eased financial conditions in the past and, so far, looks to be effective again," Fed Chairman Ben S. Bernanke wrote in a Washington Post opinion article published Thursday. "Stock prices rose and long-term interest rates fell when investors began to anticipate this additional action. . . . Increased spending will lead to higher incomes and profits that, in a virtuous circle, will support economic expansion."
On Wednesday, interest rates edged up after the announcement, signaling that some investors had expected the Fed to announce a larger volume of purchases.
Mortgage and other interest rates could again decline in the coming months if the economy weakens and the Fed expands its purchases further. But those rates could just as easily increase if the economy starts picking up and the Fed ends its purchases as scheduled, or perhaps curtails them sooner. The action might also be suspended or scaled back if inflation spikes to dangerous levels.