Fed splits over $400bn stimulus for US economy

 

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The Independent Online

The Federal Reserve launched a bigger-than-expected effort to stoke the ailing US economic recovery last night, aiming to screw down long-term interest rates including mortgage rates.

Despite continuing divisions in its ranks, the Federal Open Market Committee said it would shift $400bn of its investments in US government debt to longer-term bonds, in a widely-anticipated move dubbed "Operation Twist".

And it added another new element to its loose monetary policy, a promise to buy more mortgage-backed securities. It had previously been letting its portfolio of such securities dwindle, and the change is designed to encourage banks to lend to homebuyers and existing homebuyers who want to refinance.

The measures, the committee said, are needed because of "significant downside risks to the economic outlook, including strains in global financial markets".

The Fed has already pumped more than $2 trillion (£1.3trn) of new money into the economy through the purchases of US Treasuries and other bonds, a programme called quantitative easing that increases the demand for bonds and therefore pushes down interest rates. The bond buying has often been concentrated in short-term Treasuries, though. Operation Twist is designed to more closely target the long-term rates that most affect mortgage rates and the cost of borrowing for businesses in the real economy.

Under Operation Twist, the Fed will replace some of its portfolio of short-term Treasury debt with longer-term bonds, including more than $100bn of debt with a maturity of 20 years or more.

"This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative," the FOMC said. "Economic growth remains slow. Recent indicators point to continuing weakness in overall labour market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months."

The members of the FOMC are still more divided than they have been for two decades over how much, if any, additional monetary stimulus is needed and how much can be safely applied without stoking inflation. Last month, the committee declared it would hold short-term interest rates at zero for two more years, but that plan provoked three dissenting votes.

The September meeting was extended from one to two days so that members could have a wider debate on economic philosophy and on the latest data, and consider a wider range of policy measures that the Fed might use. Despite the extra time, no consensus emerged and the latest FOMC statement again noted three dissenters.

The FOMC met in a highly-charged political environment, in which the Fed has been heavily criticised by contenders for the Republican presidential nomination. Ben Bernanke, chairman, was accused of treason by frontrunner Rick Perry, and on Tuesday, Republicans wrote to the committee urging it to "resist further extraordinary intervention in the US economy".

In the letter, signed by the four most senior Congressional Republicans, they said: "Although the goal of quantitative easing was, in part, to stabilise the price level against deflationary fears, the Federal Reserve's actions have likely led to more fluctuations and uncertainty in our already weak economy."

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