The Federal Reserve is prepared to make a fresh purchase of Treasury bonds to help spur the economy but has not decided on the size of the program, Chairman Ben Bernanke said Friday.
Speaking at a Fed conference in Boston, Bernanke also indicated that policymakers are trying to craft a plan to lift inflation from super-low levels. He said the Fed must weigh the risks of a Treasury-buying program and determine how the debt purchases would be paced. The Fed's bond purchases would be intended to lower long-term interest rates to stimulate buying and spending and help lower unemployment.
Fed policymakers are widely expected to announce a Treasury buying program at their next meeting Nov. 2-3. Investors have been pushing stock prices higher in recent days, in part because they think the Fed will begin buying the bonds to help bolster the economy.
"There would appear — all else being equal — to be a case for further action," Bernanke said.
World stocks rose after Bernanke's remarks. But the prospect of more dollars swirling around the financial system did nothing to help the dollar itself, which slid further after the Fed chief spoke.
The economy is growing at a pace "less vigorous than we would like," Bernanke acknowledged.
Unemployment, now at 9.6 percent, has been stuck near double digits for more than a year. Bernanke indicated that the Fed is concerned that economic growth is likely to remain lackluster and that unemployment will decline only slowly next year. High unemployment is likely to keep consumers cautious in their spending.
During the recession, the Fed launched a $1.7 trillion program, buying a mix of mortgage securities and government debt. The effort was credited with forcing down mortgage rates and providing support to the weakened housing market.
The new program is likely to be smaller. One Fed official has suggested a $500 billion program, while another has suggested it be $100 billion or less.
The Fed is again resorting to such unconventional methods — called quantitative easing — to stimulate the economy because it has already sliced its key interest rate to a record low near zero. The anticipated second round is being dubbed "quantitative easing two."
What is 'quantitative easing?'
It's a policy to place more money directly into the economy. The Federal Reserve creates money and then uses it to buy Treasury bonds directly from individual banks, increasing their reserves. The banks then are supposed to use that new cash to increase loans, thus stimulating growth.
What does the Fed hope to accomplish?
The Fed wants to stimulate growth by putting more money into the economy, and encourage a small amount of inflation to counteract any deflationary pull in the economy.
Scott Sumner, an economics professor at Bentley University in Waltham, Mass., said as much as anything, the Fed's goal is to shape expectations of the economy's direction.
"The Fed is really trying to send signals that it will push up inflation," Sumner said. "They are trying to create an impression in the markets that they won't fall into the same (deflationary) trap as Japan in the 1990s."
What are the potential down sides?
Stimulating inflation could work too well. If the economy picks up and the Fed doesn't act quickly enough to put the brakes on, there's the possibility of hyperinflation. "But the Fed is quite confident that it can basically suck the money back out of the economy as soon as we get a real turnaround," Sinclair said.
Also, the new policy might not work or might be too little too late. "Quantitative easing hasn't been studied that much and so there's not a good notion for how much would be needed," Sinclair said.
"Bernanke gives green light for QEII," TJ Marta, a market strategist at Marta on the Markets, said after Bernanke's speech.
For now, the Fed is more interested in seeing prices rise rather than fall.
Because the economy is weak, "the risk of deflation is higher than desirable," Bernanke said. Deflation is a widespread drop in prices, wages and the values of stocks and homes.
As Bernanke was speaking, the government issued a report that pointed to why a new Treasury-buying program may be necessary to ward off deflation. Consumer prices excluding the volatile categories of food and energy were flat for a second straight month.
A prolonged drop in prices for goods, in wages and in the values of homes and stocks is dangerous for the economy and Americans' pocketbooks. It makes paying on debt much harder, causing more people to fall into foreclosures and default on credit card bills, and for companies to slide into bankruptcy.
Bernanke's comments come as the Fed is weighing steps to try to raise people's expectations of where they think inflation is heading in the months ahead.
If the Fed were to communicate that it will tolerate a higher-than-normal rate of inflation, that could make companies feel more inclined to nudge up their prices. Shoppers, thinking prices would be rising even further in the future, would be more inclined to make purchases sooner. That would lift inflation from worrisome low levels.
Such a move would push "real" or inflation-adjusted interest rates down, which could spur more spending. Fed officials at the September meeting noted that it has ways to try to influence people's expectations of inflation. One way was to include information in the minutes of the Fed meetings to try to shape people's expectations about inflation.
Addressing the nation's high unemployment, Bernanke believed much of that problem was due to the sharp contraction in business activity that occurred in the wake of the financial crisis and a lack of customer demand since then.
Some economists have argued that unemployment is high because of two primary factors. Workers face difficulties moving to new cities where jobs may be available, mostly because they worry about being able to sell their homes in depressed housing markets. They also note a mismatch between the skills workers have and the ones companies want.
Bernanke's speech came amid other mixed economic news Friday.
Consumer prices rose slightly last month. The Labor Department said the Consumer Price Index went up a slim 0.1 percent. Outside of volatile food and energy costs, the core CPI was unchanged.
The core CPI has been flat for the past year, which has kept inflation at bay. But it also raises the risk of tipping the economy toward deflation — a widespread drop in prices of goods and services, which can set off a spiral of falling profits.
In the past 12 months, core prices rose only 0.8 percent, the smallest yearly gain in more than 49 years.
"We need stronger growth," said Aaron Smith, an economist for Moody's Economy.com. "It's going to take some time to mop up the slack in the economy. But in order to do that, we need significantly stronger growth than we have right now."
But retail sales were up in September for the third month in a row, following declines in May and June.
Retail sales rose 0.6 percent last month, the Commerce Department reported. That followed an even better 0.7 percent August increase, the biggest advance since March.
Also, businesses increased their inventories for an eighth consecutive month in August even though overall sales slowed significantly.
Business inventories rose 0.6 percent in August after a 1.1 percent rise in July, the Commerce Department reported Friday. Total business sales were up a slight 0.1 percent following a much stronger 0.8 percent advance in July.
Material from The Associated Press was used in this story.