September 21, 2010 / 2:15 PM / 9 years ago

Q+A: What could prompt more Fed easing?

(Reuters) - The Federal Reserve said on Tuesday it is prepared to provide more support to the economy if needed to bolster a slowing economic recovery and nudge up below-target inflation.

The central bank made no shift in monetary policy at the end of a one-day meeting but expressed somewhat greater concern about the economic outlook and low inflation, inching closer to a decision to ease policy further.

The Fed has already slashed short-term interest rates to near zero and pumped more than $1.7 trillion into the economy through purchases of Treasury and mortgage-related debt.

If policymakers decide to take further steps, they are likely to be in the form of further large-scale Treasury bond purchases.

WHAT COULD TRIGGER MORE FED EASING?

— Lowering of 2011 economic forecasts

Fed Chairman Ben Bernanke said last month the Fed would need to see a significant deterioration in economic conditions before easing further.

Given the lag with which monetary policy affects the economy, investors will need to keep an eye on forecasts for 2011 growth.

— Stubbornly high unemployment rate

Former Fed Vice Chairman Donald Kohn, who retired on September 1, told the New York Times he would want to make sure the economy was on track to pull down the jobless rate and move inflation a bit higher.

— Deflation fears go mainstream

Philadelphia Federal Reserve Bank President Charles Plosser told Reuters he would like to hold off on further easing unless there are signs deflationary expectations are building.

— Another shock to the system

Dallas Fed President Richard Fisher told Reuters only a financial system shock or some other unforeseen circumstance should push the Fed into doing more.

WHY IS FED SPLIT OVER WHETHER IT SHOULD ACT FURTHER?

Bernanke has framed the debate on further easing as a cost-benefit analysis.

This means there are many different fault lines along which Fed officials can disagree: on the outlook for the economy, the effectiveness of tools and the costs of using those tools.

— Outlook for the economy

Officials differ on whether the recovery is merely working its way through a soft patch or whether the recovery may be truly faltering and needs support.

— Effectiveness

Fisher has argued that regulatory and fiscal uncertainty is hindering the appetite among businesses to expand, putting the ball in the government’s court. Clear up those uncertainties, he argues, and animal spirits will flow again.

— Costs

Some Fed officials, including Plosser, have voiced concern about the possibility the Fed’s credibility could be damaged if it launches fresh action and is not successful in lowering the unemployment rate. He and others also worry about distorting markets and laying the groundwork for future inflation.

However, it is likely policymakers would rally to act if the recovery appeared to be in serious trouble.

WHAT WOULD FED HOPE TO ACHIEVE WITH MORE EASING?

If the Fed resumed purchases of longer-term U.S. Treasury debt, it would hope to further drive down long-term borrowing costs to spur economic growth and to nudge up below-target inflation.

The $1.7 trillion of purchases of securities lowered long-term borrowing costs by around half a percentage point, according to the Fed and other analysts.

In part, the Fed would want to force investors to move into other asset classes to impact a wide range of rates.

Lower U.S. borrowing costs could stimulate home buying and building, business investment and, ultimately, hiring.

If it wanted to, the Fed could also resume purchases of mortgage-related debt to more directly help housing. However, analysts say the Fed’s presence in this market is already so large any impact might be minimal and could be disruptive.

WILL THE FED EASE BEFORE THE MID-TERM ELECTIONS?

Most observers do not believe a sufficient case has been built to lead the Fed to act at its meeting this week.

The would mean the next meeting, which wraps up on November 3, would be the soonest the Fed would act.

Some analysts believe that even then Bernanke could be reluctant to pull the trigger the day after an election out of a desire to avoid appearing influenced by politics.

Six of 15 analysts at top banks that deal directly with the Fed expect the central bank to embark upon more easing before the end of the year.

Reporting by Kristina Cooke, Ann Saphir and Mark Felsenthal; Editing by Chizu Nomiyama

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