December 3, 2012 / 7:51 PM / in 6 years

UPDATE 2-Fed's Bullard urges smaller bond buys to replace Twist

* Bullard: replacing Twist one-for-one could stoke inflation

* Says that Fed could drop buying to $25 bln a month

By Alister Bull

LITTLE ROCK, Ark., Dec 3 (Reuters) - The Federal Reserve could replace its expiring Operation Twist with a smaller program of outright Treasury purchases and still give the same boost to the economy, a senior U.S. central bank said on Monday.

St. Louis Federal Reserve Bank President James Bullard said simply replacing the scale of Twist, under which the Fed buys $45 billion in long-term Treasuries each month, and sells a like amount of short-term Treasuries, could stoke inflation.

He told the Wall Street Journal the Fed could lower its buying to $25 billion a month and get the same policy impact, and further outlined this argument in subsequent remarks.

“If the goal is to keep policy on its present course, the replacement rate should be less than one-for-one,” he told the Little Rock Chamber of Commerce.

Twist, which is part of the Fed’s aggressive action designed to push down borrowing costs so the economy will grow faster, will expire at the end of the year.

Many economists believe policymakers will decide to buy Treasuries outright next year to make up for the end of Twist, and will announce a decision at their Dec. 11-12 meeting.

Some policymakers have suggested the Fed should fully replace Twist with outright Treasury purchases next year. But Bullard, who will be a voting member of the policy-setting committee in 2013, said this would add up to easier policy.

He said that outright bond buying, which would increase the size of the Fed’s already massive balance sheet, could be more “stimulative” or dovish than the current stance of Fed policy.

“You could go down to $25 billion in outright purchases and probably get the same stimulative impact,” he told the paper.

The Fed has also been buying $40 billion in mortgage-backed securities each month to help reduce unemployment, bringing the full monthly amount of purchases to $85 billion. Bullard’s plan would reduce the total to $65 billion.

“Replacing the expiring Twist program one-for-one with outright purchases of longer dated Treasuries is likely a more accommodating policy,” he said in Little Rock.

The Fed cut interest rates to almost zero in late 2008 to help the U.S. economy weather a severe recession and says it will hold rates steady until at least mid-2015.

It has also more than tripled the size of its balance sheet, to over $2.8 trillion, through purchases of Treasury and mortgage-backed securities, also called quantitative easing.

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