Fed's rate power 'limited' - But other tools available

The Straits Times
Dec 2, 2008 | 6:03 AM
Fed's rate power 'limited'

WASHINGTON - THE Federal Reserve has limited scope to cut interest rates further to stimulate the economy but other tools are available, such as the purchase of long-term Treasury securities, chairman Ben Bernanke said on Monday.

'Although further reductions from the current federal funds rate target of 1.0 per cent are certainly feasible, at this point the scope for using conventional interest rate policies to support the economy is obviously limited,' Mr Bernanke said in a speech to the chamber of commerce in Austin, Texas.

Mr Bernanke said there were other measures the central bank could take to expand its lending to financial institutions battered by a global credit crisis and stimulate the faltering economy.

The Fed already has pumped hundreds of billions of dollars into the financial system, slashed interest rates and taken unprecedented steps to open its cash spigot to banks and other financial institutions.

Mr Bernanke noted there were 'several means by which the Fed could influence financial conditions through the use of its balance sheet, beyond expanding our lending to financial institutions'.

'The Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities,' he said. 'This approach might influence the yields on these securities, thus helping to spur aggregate demand.'

He also noted the Fed could provide 'backstop liquidity not only to financial institutions but also directly to certain financial markets, as we have recently done for the commercial paper market'.

But the central bank chairman cautioned that such an expansion of the Fed's balance sheet could trigger a damaging inflation spiral and thus should be of a limited, emergency duration.

'To avoid inflation in the long run and to allow short-term interest rates ultimately to return to normal levels, the Fed's balance sheet will eventually have to be brought back to a more sustainable level,' Mr Bernanke said.

The policy-setting Federal Open Market Committee (FOMC) 'will ensure that that is done in a timely way,' he said.

'However, that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy.'

The FOMC in October cut the key federal funds target rate by half a point to 1.0 per cent, matching the lowest rate since the central bank began using the target for interbank loans.

Some analysts expect the FOMC to lower the base rate by a half point at its next meeting on December 15-16. -- AFP