Fed likely to revamp bond purchases to aid economy
WASHINGTON (AP) — The Federal Reserve is expected to announce a revamped bond-buying plan Wednesday to maintain its support for the U.S. economy.
The Fed's goal would be to keep downward pressure on long-term interest rates and encourage individuals and companies to borrow and spend. If it succeeds, the Fed might at least soften the blow from tax increases and spending cuts that will kick in in January if Congress can't reach a budget deal.
But its actions wouldn't rescue the economy. Chairman Ben Bernanke warned last month that if the economy fell off a "broad fiscal cliff," the Fed probably couldn't offset the shock.
Fears of the cliff have led some U.S. companies to delay expanding, investing and hiring. Manufacturing has slumped. Consumers have cut back on spending. Unemployment remains a still-high 7.7 percent. If higher taxes and government spending cuts lasted for much of 2013, most experts say the economy would sink into another recession.
On Tuesday, the Fed began a two-day meeting, which will end Wednesday afternoon with a statement announcing its policy decisions. Afterward, the Fed will update its forecasts for the economy, and Chairman Ben Bernanke will hold a news conference.
The expectation is that the Fed will unveil a program to buy $45 billion a month in long-term Treasurys. This would replace an expiring program called Operation Twist. With Twist, the Fed sold $45 billion a month in short-term Treasurys and used the proceeds to buy the same amount in longer-term Treasurys.
Twist didn't expand the Fed's investment portfolio; it just reshuffled the holdings. But the Fed has run out of short-term securities to sell. So to maintain its pace of long-term Treasury purchases and help keep long-term rates low, it must spend more and increase its portfolio.
The new bond purchase plan would join a program announced in September. Under that program, the Fed is buying $40 billion a month in mortgage bonds to try to force already record-low home-loan rates lower to encourage home buying. The total Fed bond purchases from the two programs would remain $85 billion.
"The Fed really has only one key decision at the meeting, and that is how much of the current program will they replace," said David Jones, chief economist at DMJ Advisors.
If, on the other hand, the Fed chooses not to replace Twist with a new bond-buying program, the value of its long-term Treasury purchases will decline by half. Long-term borrowing rates might rise as a result.
When the Fed pumps more money into the financial system and adds to its portfolio, it's called quantitative easing, or QE. Critics argue that QE risks escalating inflation later. The Fed's portfolio totals nearly $2.9 trillion — more than three times its size before the 2008 financial crisis.
The Fed has launched three rounds of QE since the financial crisis hit. In announcing QE3 in September, the Fed said it would keep buying mortgage bonds until the job market improved substantially. It also extended its plan to keep its benchmark short-term rate near zero through at least mid-2015. And it raised the possibility of taking other steps.
Skeptics note that rates on mortgages and many other loans are already at or near all-time lows. So any further declines in rates engineered by the Fed might offer little economic benefit.
But besides seeking to spur lending, the Fed's drive to cut rates has another goal: to induce investors to shift money out of low-yielding bonds and into stocks, which could lift stock prices. Stock gains boost wealth and typically lead individuals and businesses to spend and invest more. The economy would benefit.
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