Fed Weighs New Tactics to Bolster Recovery
SEPTEMBER 27, 2010, 4:57 P.M. ET
By JON HILSENRATH
Federal Reserve officials are considering new tactics if they resume
purchases of long-term U.S. Treasury securities to bolster a
disappointingly slow recovery.
Rather than announcing massive bond purchases with a finite end, as they
did in 2009 to shock the U.S. financial system back to life, Fed
officials are weighing a more open-ended, smaller-scale program that
they could adjust as the recovery unfolds.
The Fed hasn't yet decided to step up its bond purchases, let alone
agree on an approach. After its last meeting, the Fed's policy committee
said it was "prepared" to take new steps if needed. A call on whether
to buy more bonds depends on incoming data about economic growth and
inflation; if the economy picks up steam, officials might decide no
action is needed.
In March 2009, the Fed said it would buy $1.7 trillion worth of Treasury
and mortgage-backed securities over a six to nine month period—known
inside the Fed as the "shock and awe" approach. Most Fed officials
believe that helped to drive down long-term interest rates and spurred
the economy.
Under the alternative approach gaining favor inside the Fed, it would
announce purchases of a much smaller amount for some brief period and
leave open the question of whether it would do more, a decision that
would turn on how the economy is doing. The approach would give them
more flexibility in the face of an uncertain recovery.
Most economists at the Fed and outside, though not all, believe that the
Fed's decision to embark on what's known as "quantitative
easing"—buying bonds—after cutting its target for short-term interest
rates to nearly zero helped prevent an even deeper recession.
A move to resume the purchases would be a big decision for the Fed,
which just a few months ago was talking about how to reduce its
portfolio. In deciding how to resume its large-scale purchases, if it
decides to do so, the Fed is considering both the potential benefits of
pushing down already-low long-term interest rates and the potential
risks, particularly to its credibility in financial markets about its
ability and willingness to reverse course if the economy rebounds or
inflation accelerates.
Fed officials have done little to dissuade investors from the idea that
they might do more. Fed Chairman Ben Bernanke last week reiterated his
dissatisfaction with the recovery, saying the economy has failed to grow
"with sufficient vigor to significantly reduce the high level of
unemployment."
Markets anticipate the Fed will pull the trigger, barring some surprise
turn in the economy. Goldman Sachs estimates the Fed will end up
purchasing at least another $1 trillion in securities, and estimates
that would push long-term interest rates down by another 0.25 percentage
point.
A leading public proponent of a baby-step approach, James Bullard, a
20-year Fed veteran who has been president of the St. Louis Federal
Reserve Bank since 2008, says he has made progress convincing his
colleagues to seriously consider that approach. "The shock-and-awe
approach is rarely the optimal way to conduct monetary policy," he says.
"I really do not think it is the right way to go except in really
exceptional circumstances."
In the heat of the crisis it made sense to jar frozen markets back to
life with a big attention-grabbing program, he says. Announcing another
big program with a finite end-date now, he says, would lock the Fed into
a policy that might not be appropriate several months from now.
Moreover, a large commitment could destabilize markets by unhinging the
dollar or creating fears of a big inflation uptick, he said.
Under a small-scale approach, Mr. Bullard says, the Fed might announce
some target for bond buying, say $100 billion or less per month. It
would then make a judgment at each meeting whether continued action was
needed, he says, based on whether "we're making progress toward our
mandate of maximum sustainable employment and inflation at our implicit
inflation target."
There are many open questions. One is size. Mr. Bullard says the idea of
doing more than $1 trillion of purchases a year "gives me pause"
because that is how much net debt the Treasury will issue this year,
meaning the Fed would be financing it all. There is also a question of
whether the Fed might tie further action to movements in the
unemployment rate, inflation or other metrics.
Mr. Bullard is among 12 regional Fed bank presidents with a vote on
monetary policy, along with the four current Fed governors in
Washington. He has been arguing for this kind of approach to Fed policy
for several months, but only began to get traction with other officials
as the economy slowed this summer.
The Fed is not of one mind on the issue, though. Some officials are
reluctant to resume bond buying to, as they put it, "fine tune" the
economy. Others are more inclined to be bold to resuscitate the
recovery.
A small-scale approach could be a path to compromise among officials.
"Given the disagreement about the need for additional easing within the
FOMC, retaining some flexibility might be critical to the adoption" of
more quantitative easing, Goldman Sachs analysts said recently.
The Goldman economists estimate that an open-ended, small-scale approach
would have less impact on bond markets than a large one-time approach,
because investors wouldn't be certain about whether such a program would
continue. "The more you commit to large amount of purchases up front,
the bigger effect you're going to get," says Jan Hatzius, Goldman's
chief economist.
The Fed has already pushed short-term interest rates to zero. In theory,
buying long-term bonds pushes other interest rates down because it
reduces the supply of debt available to investors, pushing up the price
of this debt and the yield down.
The Fed concluded its $1.7-trillion purchases of mortgage and Treasury
bonds in March. Researchers at the Federal Reserve Bank of New York
estimate that the program reduced long-term interest rates by between
0.3 percentage point and one full percentage point.
The Fed took a step toward new purchases in August, when it said it
would begin replacing maturing mortgage bonds by purchasing Treasury
debt to keep the overall level of its securities holdings constant.
Write to Jon Hilsenrath at jon.hilsenrath@wsj.com
By JON HILSENRATH
Federal Reserve officials are considering new tactics if they resume
purchases of long-term U.S. Treasury securities to bolster a
disappointingly slow recovery.
Rather than announcing massive bond purchases with a finite end, as they
did in 2009 to shock the U.S. financial system back to life, Fed
officials are weighing a more open-ended, smaller-scale program that
they could adjust as the recovery unfolds.
The Fed hasn't yet decided to step up its bond purchases, let alone
agree on an approach. After its last meeting, the Fed's policy committee
said it was "prepared" to take new steps if needed. A call on whether
to buy more bonds depends on incoming data about economic growth and
inflation; if the economy picks up steam, officials might decide no
action is needed.
In March 2009, the Fed said it would buy $1.7 trillion worth of Treasury
and mortgage-backed securities over a six to nine month period—known
inside the Fed as the "shock and awe" approach. Most Fed officials
believe that helped to drive down long-term interest rates and spurred
the economy.
Under the alternative approach gaining favor inside the Fed, it would
announce purchases of a much smaller amount for some brief period and
leave open the question of whether it would do more, a decision that
would turn on how the economy is doing. The approach would give them
more flexibility in the face of an uncertain recovery.
Most economists at the Fed and outside, though not all, believe that the
Fed's decision to embark on what's known as "quantitative
easing"—buying bonds—after cutting its target for short-term interest
rates to nearly zero helped prevent an even deeper recession.
A move to resume the purchases would be a big decision for the Fed,
which just a few months ago was talking about how to reduce its
portfolio. In deciding how to resume its large-scale purchases, if it
decides to do so, the Fed is considering both the potential benefits of
pushing down already-low long-term interest rates and the potential
risks, particularly to its credibility in financial markets about its
ability and willingness to reverse course if the economy rebounds or
inflation accelerates.
Fed officials have done little to dissuade investors from the idea that
they might do more. Fed Chairman Ben Bernanke last week reiterated his
dissatisfaction with the recovery, saying the economy has failed to grow
"with sufficient vigor to significantly reduce the high level of
unemployment."
Markets anticipate the Fed will pull the trigger, barring some surprise
turn in the economy. Goldman Sachs estimates the Fed will end up
purchasing at least another $1 trillion in securities, and estimates
that would push long-term interest rates down by another 0.25 percentage
point.
A leading public proponent of a baby-step approach, James Bullard, a
20-year Fed veteran who has been president of the St. Louis Federal
Reserve Bank since 2008, says he has made progress convincing his
colleagues to seriously consider that approach. "The shock-and-awe
approach is rarely the optimal way to conduct monetary policy," he says.
"I really do not think it is the right way to go except in really
exceptional circumstances."
In the heat of the crisis it made sense to jar frozen markets back to
life with a big attention-grabbing program, he says. Announcing another
big program with a finite end-date now, he says, would lock the Fed into
a policy that might not be appropriate several months from now.
Moreover, a large commitment could destabilize markets by unhinging the
dollar or creating fears of a big inflation uptick, he said.
Under a small-scale approach, Mr. Bullard says, the Fed might announce
some target for bond buying, say $100 billion or less per month. It
would then make a judgment at each meeting whether continued action was
needed, he says, based on whether "we're making progress toward our
mandate of maximum sustainable employment and inflation at our implicit
inflation target."
There are many open questions. One is size. Mr. Bullard says the idea of
doing more than $1 trillion of purchases a year "gives me pause"
because that is how much net debt the Treasury will issue this year,
meaning the Fed would be financing it all. There is also a question of
whether the Fed might tie further action to movements in the
unemployment rate, inflation or other metrics.
Mr. Bullard is among 12 regional Fed bank presidents with a vote on
monetary policy, along with the four current Fed governors in
Washington. He has been arguing for this kind of approach to Fed policy
for several months, but only began to get traction with other officials
as the economy slowed this summer.
The Fed is not of one mind on the issue, though. Some officials are
reluctant to resume bond buying to, as they put it, "fine tune" the
economy. Others are more inclined to be bold to resuscitate the
recovery.
A small-scale approach could be a path to compromise among officials.
"Given the disagreement about the need for additional easing within the
FOMC, retaining some flexibility might be critical to the adoption" of
more quantitative easing, Goldman Sachs analysts said recently.
The Goldman economists estimate that an open-ended, small-scale approach
would have less impact on bond markets than a large one-time approach,
because investors wouldn't be certain about whether such a program would
continue. "The more you commit to large amount of purchases up front,
the bigger effect you're going to get," says Jan Hatzius, Goldman's
chief economist.
The Fed has already pushed short-term interest rates to zero. In theory,
buying long-term bonds pushes other interest rates down because it
reduces the supply of debt available to investors, pushing up the price
of this debt and the yield down.
The Fed concluded its $1.7-trillion purchases of mortgage and Treasury
bonds in March. Researchers at the Federal Reserve Bank of New York
estimate that the program reduced long-term interest rates by between
0.3 percentage point and one full percentage point.
The Fed took a step toward new purchases in August, when it said it
would begin replacing maturing mortgage bonds by purchasing Treasury
debt to keep the overall level of its securities holdings constant.
Write to Jon Hilsenrath at jon.hilsenrath@wsj.com
Tags: Federal, Quantitative, Reserve, easing, economic, recovery
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