How Fed's plan to buy more gov't bonds will work
Wednesday, November 3, 2010; 6:19 PM
-- How the Federal Reserve's new government bond-buying program will operate:
- To buy Treasury debt, the Fed in effect prints money. It does so by expanding its balance sheet, which now stands at $2.3 trillion. The balance sheet has nearly tripled since the end of 2007. That's when the economy slid into recession and the Fed embarked on programs to loosen credit.
- The Federal Reserve Bank of New York actually buys the longer-term government debt. It will buy $600 billion in longer-term Treasury securities by the middle of 2011. In addition, it will use $250 billion to $300 billion in proceeds from its mortgage portfolio to buy government debt over the same period.
Altogether, that translates into the Fed buying, on average, $110 billion a month. Most of those government securities will be in the two- to 10-year range. But roughly 4 percent of the total purchases will be in the 17- to 30-year maturities.
The New York Fed will buy the bonds electronically on the open market. In doing so, it will compete with other investors. During the recession, when the Fed cut its key interest rate to a record low near zero, the New York Fed bought short-term Treasurys. When the Fed wants to tighten credit, the New York Fed sells securities. The process is called "open market operations."
THE ECONOMIC MISSON:
- As the Fed snaps up Treasury bonds, the rates on those bonds will fall. Rates on mortgages, corporate debt and other loans pegged to the Treasury securities will drop, too. It involves supply and demand: Higher demand for bonds lowers their rates, or yields. And it drives up their prices.
- The Fed's goal is for those cheaper loans to entice Americans to spend more. Stronger sales could make businesses borrow and spend and hire more employees. Those forces could generate more business activity and strengthen the economy.