Fed steps up investment in debt

The Federal Reserve is taking another multibillion-dollar run at boosting the sputtering economy. It announced Wednesday that it would buy another $600 billion in government debt. The move is on top of a previously announced $250 billion to $300 billion investment. The hope is that the up to $900 billion overall investment will lead consumers to pull out their wallets more often and also encourage companies to invest more — by hiring more people and buying more equipment, commodities and whatever else they need to do business. More hiring — and investing — leads to more people spending, which leads to even more hiring, and so on, until the economy is back on its feet. That's the theory, at least.

How it works

The Federal Reserve uses the electronic equivalent of a printing press to create money to buy U.S. Treasury bonds. The significant investment lowers the rate of return on the bonds. Overall interest rates fall, because they are closely tied to the U.S. Treasury rates. Lower interest rates make it easier to borrow money, which spurs consumer spending and business investment.

Why this move?

Traditionally, the Fed would simply lower short-term interest rates instead of going through the trouble of buying up Treasury bonds. But those rates are already hovering at close to zero. Also, the Fed has had some recent success with a similar program. From December 2008 to March 2010, the Fed spent $1.7 trillion on Treasuries and other securities, a move widely credited with helping keep the economy from further collapse.

Effect on the average Joe and Jane

A healthier economy has a wide range of long-term benefits. More immediately, the Fed's move could help homeowners with good credit scores and some equity refinance at a lower rate. It also might boost their 401(k)s and other investments, since the Fed hopes that lower rates on Treasury bonds will push investors into riskier investments like stocks, which should increase their value.

The downsides

There are many, depending on whom you ask. There is wide agreement that such a move usually weakens the U.S. dollar. Creating so much extra money could also touch off new asset bubbles as investors flock from Treasury bonds to other investments. Commodity prices also could rise, triggering runaway inflation. When the time comes, the Federal Reserve will have to deftly withdraw all that extra money, or it will again risk unwelcome inflation.

What they are saying

"(Federal Reserve Chairman Ben) Bernanke has nearly pleaded with Congress for fiscal stimulus, but he can't count on it. So he has to act as if that's not going to happen."

Laurence H. Meyer, a former Fed governor

"When the Fed realizes that (this move) isn't working, it will have two choices: Admit this is a lost cause or increase the size of its purchases. … Now that the Fed has started down this road again, it will be very hard to stop unless there are clear signs of improvement in the economy."

Paul Ashworth, Capital Economics

Compiled by Times Business editor Graham Brink with information from Times wires and the Wall Street Journal.

Fed steps up investment in debt 11/03/10 [Last modified: Wednesday, November 3, 2010 9:58pm]

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