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Out of ammo, Federal Reserve invents new guns

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See updated story: Federal Reserve, out of ammo, invents new ways to stimulate economy

With no room to lower interest rates further, the Federal Reserve today announced plans to instead invent alternate means to prop up the economy.

Fed rates unchanged
Fed funds rates, Sept. 2007 through Jan. 2009
Source: CreditCards.com rate report, Federal Reserve

At its last meeting, after cutting its key lending rate to effectively zero, the Fed had promised to "employ all available tools" in order to stimulate a dragging economy. They maintained that focus today, while adding some new details as to exactly what those tools might be.

"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability," the central bank said in a statement released Wednesday. "The focus of the Committee's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets. The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Committee will continue to monitor carefully the size and composition of the Federal Reserve's balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability."

Since the Fed can't lower interest rates any further, there will be little immediate impact on any kinds of interest rates in the wake of the announcement, says Ann Owen, an economics professor at Hamilton College in Clinton, N.Y. "The best the Fed can do is to try to manage expectations, both about the future path of interest rates and price levels," Owen says. "By communicating that it expects to keep short-term interest rates low for the foreseeable future, it can try to lower long-term rates further."

In its previous two-day meeting, which concluded on Dec. 16, 2008, the Federal Open Markets Committee cut the target for the benchmark federal funds rate to a range of 0 percent to 0.25 percent. That decision was approved unanimously by committee members.

Previously, the rate's all-time record low was 1 percent, hit most recently in October 2008 and before then from June 2003 to June 2004. Prior to the Fed's campaign of rate reductions in September 2007, the federal funds rate stood at 5.25 percent.  

Fed changes to monetary policy alter the fed funds rate and, by extension, the prime rate, to which many credit cards are pegged. However, with the fed funds rate already effectively lowered to zero and no one considering raising the rate in today's difficult economy, the days of the central bank altering the rate to boost the economy are over for now, experts say.  

"Monetary policy is done," says Susan Menke, senior financial services analyst with Mintel International in Chicago. She explains that while talk often focuses on monetary policy, "In the larger scheme of things, it's not the most important thing going on -- and now it's certainly not," Menke says. In its place, she sees another opportunity for economic recovery: "The stimulus package is it," Menke adds.   

The central bank primarily wants to encourage more auto and loan lending by banks, says Dennis Moroney, research director with TowerGroup, a research and advisory services firm. However, when it comes to credit cards, "What they'd really want to encourage is the banks not to be so aggressive in reducing lines," he says. In recent months, banks have aggressively targeted unused credit lines for cancellation and have lowered credit limits on a wide range of customers.

While the Fed's task is anything but easy, the problem is more clear-cut. According to Menke, the Fed needs to free up credit markets. "It's a very structural recession. Money isn't moving along," she says.

Published: January 28, 2009


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