FACTBOX-Beyond rate cuts: Other Fed tools against downturn

Dec 1 (Reuters) - Federal Reserve Chairman Ben Bernanke said on Monday that further interest rate cuts beneath the Fed's current target of 1 percent were "certainly feasible," but he also said the Fed could take other steps to support the economy.

Here are the tools Bernanke mentioned:

BUY LONGER-TERM TREASURIES

* The Fed could purchase longer-term securities issued by the Treasury or government-sponsored mortgage enterprises on the open market in substantial quantities.

"This approach might influence the yields on these securities, thus helping to spur aggregate demand," Bernanke said.

BACKSTOP LIQUIDITY

* The Fed can provide backstop liquidity not only to financial institutions but also directly to certain financial markets, as was recently done for the commercial paper market.

"Such programs are promising because they sidestep banks and primary dealers to provide liquidity directly to borrowers or investors in key credit markets," Bernanke said.

OTHER QUANTITIVE EASING OPTIONS

* Both of the options Bernanke mentioned could fall under the umbrella of "quantitative easing," which describes central bank action designed to quantitively increase the supply and circulation of money when conventional interest rate policy loses impact as it approaches zero. The Bank of Japan used quantitive easing to end a decade of stagnation in the 1990s.

* The Fed has already done this to an extent via its commercial paper lending facility and by accepting a widened range of collateral, including tarnished mortgage assets, at its discount lending window. However, Fed officials say they are still trying to keep the overnight funds rate near its target -- currently 1 percent -- although their efforts have been thwarted by massive supplies of liquidity in the system as lenders hoard money on overnight deposit and shun longer-term lending.

* The Fed could also set a direct target for reserve balances that would help it calibrate the supply of money in an environment of zero interest rates.

* The Fed has more than doubled the size of its balance sheet since September to support liquidity provision to strained financial markets. Bernanke said the Fed must eventually shrink its balance sheet to a sustainable size to prevent future inflation. But he stressed that the first priority was stabilizing financial markets and buffering growth.

PITFALLS

* These unorthodox methods of stimulating monetary policy are not without their perils. Glenn Rudebusch from the San Francisco Fed outlines these pitfalls: "It is difficult to calibrate such quantity-based monetary policy and determine the precise effects on the economy of shifts in the composition of the Fed's balance sheet or increases in the size of that balance sheet. This uncertainty about the effects of quantity-based monetary policy makes such strategies much more speculative endeavors, which may require some trial-and-error learning."

COMMITMENT TO MAINTAINING LOW RATES

* The Fed could make an explicit commitment to keeping interest rates low for a foreseeable period. This was done in 2003-2004 in an effort to bring down long-term interest rates by giving the markets clues about the path of short-term borrowing costs. But critics worry that this strategy ties the hands of Fed policy-makers, and may have contributed to fueling the housing bubble in the first place. (Compiled by Kristina Cooke, Pedro Nicolaci da Costa and Ros Krasny; Editing by Jonathan Oatis)