For Fed, Revving Up The Economy Is Tougher Than Applying Brakes

the Fed

Today's announcement from the Federal Reserve underscores an important weakness of central bankers: it is a lot easier for them to put the brakes on the economy than it is to rev it up.

After all, when the economy is in overdrive, the Fed can keep raising interest rates as much as it needs to. But when the economy is in the doldrums, it can cut them only down to zero or close to it, the situation we have today.

The Federal Open Market Committee said it would keep its benchmark interest rate near zero because the economy has slowed since it last met in June. Unlike earlier this year, when the Fed was talking about recovery, economic conditions now likely warrant "exceptionally low levels of the federal funds rate for an extended period," the committe said.

But after months at rock bottom, keeping the interest rates that low won't have much impact. That's why the Fed is forced to tinker with other strategies, like one outlined in the Fed's announcement Tuesday. The Fed said it would keep money in the economy by continuing to buy Treasury bonds, paying for them with principal payments from debt it holds.

That technique "is a less precise mechanism, and we have little experience with it," says David Resler, chief U.S. economist at Nomura Securities. Some economists say reinvesting the proceeds from mortgages and other debt into Treasurys could set the scene for bigger asset purchases in the future.

"The tools to fight recession are not very well understood," says Joseph Mason, an economist and finance professor at Louisiana State University. At the start of the crisis, he said, the Fed successfully initiated techniques such as cutting rates and buying securities that got the economy growing again. But finishing off the strategy correctly is harder than starting it, he says.

But by continuing to buy Treasurys, the Fed is sending an important message that "it can act and will act to avoid deflation in this economy," says Resler. By keeping money available to stabilize prices, the Fed is trying to prevent an expectation taking hold that prices will fall.

Given that today's policies are somewhat unconventional, "you don't know what the implications are, long term," says James O'Sullivan, U.S. economist at MF Global. "This isn't going to be the final word."



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