Fed could get specific on goals if recession hits

WASHINGTON Fri Sep 2, 2011 4:46pm EDT

The U.S. Federal Reserve building is seen in Washington June 29, 2011. REUTERS/Jim Bourg

The U.S. Federal Reserve building is seen in Washington June 29, 2011.

Credit: Reuters/Jim Bourg

WASHINGTON (Reuters) - A darkening U.S. economic outlook is forcing Federal Reserve officials to dig ever deeper into an already depleted policy toolkit and consider measures until recently deemed too radical.

A new U.S. downturn could prompt policymakers to take the aggressive step of setting specific economic guideposts for the direction of interest rates.

August jobs data pointed to a labor market teetering on the edge of recession, and investors are looking for the Fed to take some sort of action in September -- probably an additional further effort to push down long-term interest rates.

But if things get worse, baby steps in the direction of further easing might not do the trick, pushing the central bank to be even bolder.

An approach that sets explicit targets for economic conditions would serve the twin goals of increasing transparency about the aims of policy and requiring only a verbal commitment rather than outright asset purchases, which have proven controversial.

"The next step would be to outline criteria, numerical targets for unemployment and inflation," said Mark Gertler, an economics professor at New York University who has been a consultant to the New York Federal Reserve Bank.

Such a measure could help the economy by temporarily allowing greater inflation, reducing the debt burden of businesses and consumers and giving them added incentive to spend by pushing the dollar down.

"Where they can be most effective is to signal to the markets how fast they are going to let the recovery go before they raise rates," said Gertler.

Minutes from the Fed's last meeting on August 9 suggested officials were already considering such a shift last month, even before the economic data took another turn for the worse.

"In choosing to phrase the outlook for policy in terms of a time horizon, members also considered conditioning the outlook for the level of the federal funds rate on explicit numerical values for the unemployment rate or the inflation rate," the minutes said.

BEN IN A BOX

Chicago Fed President Charles Evans has actively campaigned for a price-level target, and in interviews this week suggested the central bank should allow inflation to rise as high as 3 percent in order to spur employment.

But if Fed Chairman Ben Bernanke opts for that route, he is likely to face opposition from more-hawkish policymakers who fear inflation, once rising, could get out of control.

Even those who are not anxious about inflation might worry the move would unnecessarily box the Fed into trying to achieve a specific level of unemployment, when central bankers do not have full control of the variables affecting the labor market.

Economists widely agree the level of full employment that is consistent with non-inflationary growth can vary over time.

"This idea has come up, I was a bit cautious about it," Dennis Lockhart, the president of the Atlanta Fed, told reporters this week.

Last month, the Fed took the unprecedented step of saying it expected to keep interest rates near zero for at least another two years, an effort to put downward pressure on long-term borrowing costs.

However, the economy continues to look sickly.

The prospect of a renewed downturn appeared heightened after the government said on Friday that the U.S. job market failed to add jobs last month for the first time in nearly a year, while the unemployment rate remained stuck at 9.1 percent.

Against that backdrop, the Fed could begin to ponder employing even some of the more controversial policy options left in its toolbox.

BRACING FOR A TWIST

What will the Fed do in the very near term?

Many analysts are expecting some sort of fresh policy announcement at the Fed's next meeting on September 20-21.

Expectations of action grew last week when Bernanke announced that the meeting, originally scheduled for one day, was being expanded to two to allow more time for officials to discuss their options.

"I am expecting them in some way to talk about extending the maturity of their holdings," said Dana Saporta, economist at Credit Suisse. "For Bernanke to announce that there is a two-day meeting coming up at which options will be actively discussed and then to announce the status quo at the end does not seem likely to me."

For its next easing step, the Fed would almost certainly seek to tilt its bond portfolio toward longer-dated maturities to try to put more downward pressure on long-term interest rates. It is unclear, however, exactly how the Fed might shift its portfolio.

The more modest way to do this would be to simply reinvest proceeds from maturing bonds it holds into longer-dated issues. Another way, akin to a 1961 policy known as Operation Twist, would involve actively selling securities of short duration to buy longer-term ones.

Both approaches have been actively discussed. Neither is likely to have a major economic impact, but they could bolster market psychology at a fragile time, buying policymakers time to debate more aggressive measures.

Analysts at Keefe, Bruyette and Woods even see the possibility that the Fed might eventually try to complement new efforts on housing from the administration of President Barack Obama with a new mortgage stimulus of its own.

"Down the road," they said in a research note, "we would not rule out the Fed employing a modified Operation Twist that would involve reinvesting the proceeds of maturing Treasuries into mortgage-backed securities or even selling short-dated Treasuries to buy MBS."

(Additional reporting by Margaret Chadbourn; Editing by Andrea Ricci)

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
Comments (2)
minipaws wrote:
My parents and my husbands parents depend on interest on their savings to live in retirement. The Fed has made their last few years miserable. The stress is killing them. I will never in my lifetime forgive the Fed for what it is doing to these hardworking men and women. The Fed is living in the 80′s, when lowering interest rates actually created jobs. Large and small businesses have now shipped most jobs overseas, lower interest rates won’t bring them back.

Sep 04, 2011 6:06am EDT  --  Report as abuse
USMCPatriot wrote:
One has to question the “IF” in the headline of this article. It apparently has escaped everyone associated with our government we never got out of a recession in spite of all the “recovery” rhetoric. It shouldn’t take a mental giant to figure out a consistent unemployment figure of some 14 million over three years presents no indication of “recovery.”

It should also be obvious that Keynesian macroeconomic theories are not going to pull the country out of its unemployment, budget deficit, and debt problems. What the FED may or may not do is going to do nothing but increase or indebtedness and dig a deeper hole.

Want to fix the unemployment problems, then directly provide small business entrepreneurs (100 or fewer current employees) low interest rate loans through local banks for whatever they need to improve their respective businesses and begin hiring again.

Sep 05, 2011 6:50pm EDT  --  Report as abuse
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.

Recommended Newsletters

Reuters U.S. Top News
A quick-fix on the day's news published with Reuters videos and award-winning news photography and delivered at your choice of one of four times during the day.
Reuters Deals Today
The latest Reuters articles on M&A, IPOs, private equity, hedge funds and regulatory updates delivered to your inbox each day.
Reuters Technology Report
Your daily briefing on the latest tech developments from around the world from Reuters expert tech correspondents.