The Federal Reserve is wrapping up 2012 the way it began the year, searching for ways to help a U.S. economy that is still struggling with high unemployment and sub-par growth.
The expectation is that the Fed will announce a revamped bond-buying plan at the conclusion of their second day of discussions on Wednesday. The Fed’s policy statement will be followed by the release of a revised economic outlook and a news conference with Federal Reserve Chairman Ben Bernanke.
If the central bank does revamp its bond purchases, the goal would be to keep downward pressure on long-term interest rates and encouraged individuals and businesses to borrow and spend more.
The Fed’s final meeting of the year is being held against the backdrop of the looming “fiscal cliff,” the sharp tax increases and spending cuts that will hit the economy in January if Congress and President Barack Obama are unable to reach an agreement this month to avert them.
Bernanke has said that the Fed’s efforts will not be able to rescue the economy if the budget negotiations fail and the country does go over the fiscal cliff.
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 were to last for much of 2013, most experts say the economy would sink into another recession.
The expectation is that the Fed will unveil a program Wednesday to buy $45 billion a month in long-term Treasurys. That 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 to 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 in a bid to encourage home buying. The total Fed bond purchases from the two programs would remain $85 billion.
“A little better unemployment report for November doesn’t change the Fed’s view that the economy needs additional help,” said Diane Swonk, chief economist at Mesirow Financial.
If the Fed decides not to replace Twist with a new bond-buying program, the monthly amount of its long-term Treasury purchases would 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 fueling 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.
Inside and outside the Fed, a debate has raged over whether the Fed’s actions have helped support the economy over the past four years, whether they will ignite inflation later and whether they should be extended.
The Fed is also expected to resume discussions on how to signal future policy moves to the public more clearly. Since August 2011, the Fed has identified a target date to try to reassure markets that it doesn’t plan to raise short-term rates soon. Some Fed officials, however, oppose using a target date to signal the earliest when it might start raising rates. They’ve been urging that future interest-rate moves be linked to how the economy is faring as measured by unemployment and inflation.
Many private economists expect no change in the Fed’s communications strategy this week.
Source: The Huffington Post