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Fed Leans Toward Two-Step Plan To Boost Economy

JEANNINE AVERSA   10/12/10 06:39 PM ET   AP

Fed Plan

WASHINGTON — The Federal Reserve is leaning toward taking two steps to boost the economy: Buying more Treasury bonds to drive down loan rates, and signaling an openness to higher prices later to encourage more spending now.

Fed Chairman Ben Bernanke and his colleagues appeared to be nearing consensus on those ideas at their September 21 meeting, according to minutes of the closed-door deliberations that were released Tuesday.

Economists predict Fed officials will approve the bond purchase program at their Nov. 2-3 meeting.

Fed policymakers also spoke at their last meeting about setting a higher inflation target, hoping that would get people to spend more money in short run.

The minutes showed the Fed was concerned that the economy was growing slower than they had expected. While Fed officials didn't see the economy slipping back into a recession, they worried it had become vulnerable to "potential negative shocks." They expressed concerns that unemployment, which has been at 9.6 percent for the past months, would stay elevated.

Fed officials said they were prepared to provide additional relief "before long," according to the minutes. Economists and investors took that as a sign that they are ready to act.

"The Fed is close to introducing a second round" of stimulus, Paul Ashworth, economist at Capital Economics, said the minutes showed.

Wall Street has been eagerly awaiting the Fed's decision to purchase government debt, known officially as quantitative easing. The Fed minutes signaled that move is near and lifted all major indexes.

Fed policymakers didn't settle on how big the debt purchase should be or how to structure the program. Such details are what they are wrestling with as their prepare for the November meeting.

The Fed's purchase aims to drive down interest rates on mortgages, corporate debt and other loans. It hopes that this will spur Americans to boost spending, which would strengthen the economy and ultimately chip away at the stubbornly high unemployment rate.

Public remarks by Fed officials since the September 21 meeting suggest the program will be smaller than the $1.7 trillion one it launched during the recession. Under that program, the Fed purchased a mix of mortgage securities and government debt. The effort was credited with forcing down mortgages rates and providing support to the weakened housing market.

Two Fed officials in recent remarks have suggested the new purchases shouldn't exceed $500 billion.

At the September meeting, some Fed officials thought the economic benefit of the debt purchases could be "small." A smaller program isn't expected to lower rates as much as the Fed's crisis-era program did, economists say. Moreover, there's concern that even cheaper loans will fail to get people and companies to ramp up their spending. Thus far, they haven't been confident enough in the economy or their own financial prospects to do so.

Bernanke said last week that another round of securities purchases would likely help the economy.

So far, five of the Fed's 11 voting members, including Bernanke, are leaning toward additional aid or are at least open to it. Fed Vice Chairwoman Janet Yellen, whose duties include building support for Bernanke's position, is likely to vote with the Fed chief. Fed Governors Kevin Warsh, Elizabeth Duke, Daniel Tarullo and Sarah Bloom Raskin also are likely to back Bernanke. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, however, has dissented from the Fed's decisions all year and is likely to oppose additional aid.

Speaking Tuesday in Denver, Hoenig said he isn't confident more debt purchases "will work in the real world."

William Dudley, president of the Federal Reserve Bank of New York, has estimated that a $500 billion program would provide the same amount of stimulus as a half-point or three-quarter point reduction to the Fed's main interest rate. That rate is already near zero and can't be cut further. That's why the Fed is weighing buying more government debt.

Another option to help the economy also was discussed extensively at the September meeting, according to the minutes. That deals with the Fed trying to raise people's expectations of where they think inflation is heading in the months ahead. If the Fed were to communicate that it will tolerate a higher-than-normal rate of inflation, that could make companies feel more inclined to nudge up their prices. Shoppers – thinking prices would be rising even further down the road – would be more inclined to make purchases sooner. That would lift inflation, which is now running at very low levels.

Such a move would push "real" or inflation-adjusted interest rates, down, which could spur more spending. Fed officials at the September meeting noted that there are different ways it could try to influence people's expectations of inflation. One way was to include information in the minutes of the Fed meetings to try to shape people's expectations about inflation.

It's a controversial idea that Bernanke called "inappropriate" in August, given the country's current economic circumstances. However, at the time he said such a step "might make sense" if the country were mired in a situation of prolonged deflation that weakened the public's confidence.

According to the Fed minutes, officials "saw only small odds of deflation." Deflation is a widespread drop in prices, wages and the values of stocks and homes.

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Filed by Jeff Muskus  |