Fed Could Buy Up Long-Term Treasury Bonds

The Federal Reserve's benchmark lending rate is already near zero, so it was no surprise when Fed policymakers announced they were leaving short-term rates alone. But the Fed is ready with options. One thing Fed policymakers mentioned is the possibility of buying up government Treasury bonds in a bid to keep long-term interest rates low.

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RENEE MONTAGNE, host:

We've all watched as the Federal Reserve has tried a lot of new and unconventional tactics to get the credit markets moving again. Yesterday, Fed officials said they would go even further. The central bank said it was ready to begin buying long-term government debt from the Treasury Department. That's a way of bringing interest rates down. It's a strategy with some risks, as NPR's Jim Zarroli reports.

JIM ZARROLI: Federal Reserve officials have already lowered the short-term interest rates they control directly about as far as they go. But that has so far done little to get the economy moving. And so in recent months, the Fed has been pursuing new and sometimes untested strategies aimed at making it easier to get credit. Economist Sung Won Sohn(ph) of California State University says some of these measures are succeeding.

Mr. SUNG WON SOHN (Economist, California State University): The central bank has been buying mortgages, lowering the mortgage rates significantly to a near-record low. If it weren't for the Fed, today we would be seeing much higher mortgage rates than we see.

ZARROLI: Yesterday, after its two-day meeting, the Fed issued a statement. It said it would keep pursuing these strategies, and even expand them. But it also said it was ready to do something else as well, buy up long-term US government debt, the Treasury bonds that investors all over the world buy the billions of dollars each day. Ann Owen is a former Fed economist and an associate professor at Hamilton College.

Professor ANN OWEN (Economics, Hamilton College): I think that they're trying to throw everything at this economy that they can think of. That would suggest that simply getting the credit markets working again isn't going to be enough. That they think that additional stimulus is necessary.

ZARROLI: If the Fed does begin buying long-term government debt, it will essentially be flooding the Treasury bond market with money, and Sung Won Sohn says interest rates should fall.

Mr. SOHN: Many consumer and business lending rates are tied to the Treasury yields. When Treasury yields go up, then consumer and business loan rates go up, and then vice-versa.

ZARROLI: And, he says, with interest rates lower, it will be cheaper for businesses to operate. Consumers will have more money to spend.

There are plenty of risks, however. Scott Anderson, senior economist at Wells Fargo, says the tactic amounts to monetizing government debt.

Mr. SCOTT ANDERSON (Vice President and Senior Economist, Wells Fargo): You're trading government IOUs for Federal Reserve IOUs, and that could ultimately be destabilizing for things like the dollar and U.S. inflation down the road. So I think there's a lot of reluctance in the Fed to do that.

ZARROLI: Economist Louis Crandall of Wrightson ICAP points to another potential problem. He says the Fed can flood the Treasury bond market with money by buying debt, but once it does so, it has no real control over where the money goes.

Mr. LOUIS CRANDALL (Economist, Wrightson ICAP): If you buy Treasury securities, you run the risk that the people who sell them to you will take their money to other markets around the world. There's no guarantee that they're going to reinvest in the sectors you care most about.

ZARROLI: That means foreign investors, who now hold huge amounts of U.S. government debt, could take their money back home with them, and that would rob the US economy of capital it needs to grow. But after exhausting the more traditional means of stimulating the economy, Federal Reserve officials have no choice but to venture into uncharted waters and do whatever it takes to get credit flowing again. Jim Zarroli, NPR News, New York.

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