Top economists talk unconventional Fed policy

WASHINGTON (Reuters) - The Federal Reserve meets on Monday and Tuesday for a policy-setting session that will include a discussion of unconventional steps the U.S. central bank can take to lift the economy out of recession when official interest rates are already close to zero.

Following are comments from top economists on what the Fed should consider:

FORMER FED VICE CHAIRMAN ALAN BLINDER

The one-word advice to Dustin Hoffman in The Graduate was "plastics." My one-word advice to the Fed now is "spreads." Fortunately, I don't think Ben Bernanke needs this advice. He gets it.

The problem is not that risk-free (or nearly so) interest rates are too high; rather, they are ludicrously low as investors shun risk-taking of any kind. The Fed will soon drop the funds rate to 50 bps, but this will be strictly a feel-good gesture that won't accomplish anything. That's a good thing, too, since with funds at 50 bps and Treasury bills at zero, there's no more ammunition there.

The real problem today is that market interest rates that are built over the Treasury or Fed funds base -- the rates at which real borrowers borrow and real lenders lend -- now range from high to prohibitive. If we are to get credit flowing again, the spreads must come down -- a lot. When the Fed buys commercial paper, guarantees GSE debt, or backs asset-backed securities, it is trying to reduce the spreads on each of these instruments over Fed funds or Treasuries. It should keep doing that.

FORMER IMF CHIEF ECONOMIST SIMON JOHNSON

Consumers and firms around the world are trying to save more. Private demand is still contracting almost everywhere, and this continues to cause widespread insolvency.

In the U.S., monetary policy has responded aggressively and a large fiscal stimulus is in the works, but the financial system remains weak. The real sources of danger are: a) many emerging markets teeter on the brink of default and/or a major currency crisis; and b) serious pressures in vulnerable eurozone countries.

Three main Fed actions can help forestall further damage to the U.S. economy.

1) Interest rates on loans should be lowered through direct Fed action on mortgages and in other markets. Purchases of assets by the Fed should not be sterilized by selling Treasury debt. Inflation is much preferable to deflation.

2) Establish a clear policy on how the U.S. banking system will be recapitalized if needed. The Citigroup bailout is not scalable; there are better ways to protect taxpayer value.

3) As most emerging market debts are in dollars, investors around the world are potentially short of dollars. The Fed can expand its swap lines to more countries both directly and though the IMF. When the IMF is involved, the cost of any default is shared with other countries.

PIMCO CO-CEO MOHAMED EL-ERIAN

(At Reuters Investment Summit)

The Fed has done a tremendous amount of work to stabilize the banking system and restore the commercial paper market. So the situation institutionally is not as bad as it was before. Having said that, it speaks to the simple fact that cutting interest rates is now like pushing on a string; you won't get much impact. So if they go from 100 basis points to 50, as they most likely will, in terms of impact it will be de minimis.