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Economic Forecasts

Federal Reserve to Buy Debt

With the recovery flagging, the country's monetary policymakers hope the Fed's shopping spree, pumping billions into the economy, will help.

The Federal Reserve's latest policy action is aimed less at improving the economy than at preventing further deterioration. The strategy is to buy more time, for housing to stabilize, for consumers to pay down debt and resume spending, and for economic growth to increase to a sustained 3% clip. Faced with a "disappointingly slow" economy, Fed Chairman Ben Bernanke felt that the policymakers had little choice. GDP is growing at a meager 2%, much too low to spur job creation or to lower the unemployment rate, which stands at 9.6%, a tenth of a point higher than when the recession ended in June 2009.

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With its key short-term interest rate near zero since December 2008, the Fed can't use that weapon. So it is turning to "quantitative easing," or QE. It will buy about $100 billion a month worth of Treasury debt for at least six months, effectively pumping funds into the system.

This isn't the first time the central bankers have made such a move. The Fed bought $1.75 trillion in debt in 2009. But that debt was mostly bonds backed by mortgages, and the move was aimed at reviving the mortgage market and spurring lending by lowering rates on home loans. Early this year the Fed planned to end the purchases, but it backed off when the economy slowed starting in late spring.

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Now officials have a somewhat different goal. Because trading in Treasuries is functioning well, the Fed is betting on a spillover effect benefiting other financial channels such as stocks, corporate bonds and the dollar. Bernanke figures the move will prevent mortgage rates and corporate bond rates from going up, and will support the stock market by attracting investors who turn away from lower yielding bond markets. And, as a by-product, the dollar's value will ease -- eventually paying off for U.S. exporting companies and their workers.

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Don't expect the move to deliver a big punch. Economists figure this round of QE will lower 10-year Treasury yields by about a quarter-point and boost GDP by maybe 0.3 points in 2011.

The move doesn't have the unanimous support of the country's central bankers. A handful of officials on the policy-setting Federal Open Market Committee argue that the Fed is sowing the seeds for a spurt of inflation starting in 2011. They prefer that the economy heal on its own, even if that means even higher unemployment for a while. So far, though, the dissenters are a minority. And Bernanke actually would like the QE to increase expectations of higher inflation around the bend. He's much more worried about the alternative: a stagnant economy with falling prices that leads to deflation.

What Bernanke is really wishing for is another round of fiscal stimulus from Congress, in the form of either higher spending or lower taxes. But that's unlikely, particularly given the election results. They raise the odds that partisan bickering will worsen, with inaction the outcome.

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