Fed poised to unveil new program to aid economy

[November 03, 2010]  WASHINGTON (AP) -- The Federal Reserve is poised to adopt a new plan to jolt the economy. It's a high-stakes gamble that could shape Chairman Ben Bernanke's legacy.

The Fed is all but certain to detail its plan for buying more government bonds when it wraps up its two-day meeting Wednesday. Those purchases should further lower interest rates on mortgages and other loans. Cheaper loans could lead people and companies to borrow and spend. That might help invigorate the economy, and lead companies to step up hiring.

Still, many question whether the Fed's new plan will provide much benefit.

The Fed already has driven rates to super-low levels. And anticipation of the Fed's new program has helped push down mortgage rates to their lowest points in decades. Yet the economy is still struggling.

The Fed has tried since the 2008 financial crisis to keep credit available to individuals and businesses. It's done so, in part, by keeping the target range for its bank lending rate near zero.

It also pursued the unorthodox strategy of buying long-term bonds. The Fed's purchases are so vast that they push down the rates on those bonds.

In 2009, the Fed bought $1.7 trillion in mortgage and Treasury bonds. Those purchases helped lower long-term rates on home and corporate loans. The program was credited with helping to lift the country out of recession.

The Fed's aid program this time is likely to be no more than $500 billion.

A smaller program will also be less objectionable to some Fed officials. They fret that further lowering interest rates poses long-term risks, such as runaway inflation. There's also the risk that the plan doesn't work.

Americans so far have resisted ramping up spending. Instead, many are trimming debt, rebuilding savings and trying to restore their credit.

The Fed's credibility is on the line, as is Bernanke's. The Fed chief has been credited with preventing the Great Recession from turning into the second Great Depression.

"Getting this decision right is critical to Ben Bernanke's legacy," said Kenneth Thomas, a lecturer in finance at the University of Pennsylvania's Wharton School. "He can't afford for it to backfire."

A bond-buying program of around $500 billion would likely provide only a modest boost to growth in the final months of the year. Even with that, the unemployment rate is expected to stay above 9 percent by year's end.

One option is for the Fed to announce its intention to buy a specific amount in bonds over a set number of months. After that, it would assess, at each meeting, whether it should buy more. Its decision would hinge on how the economy is faring.

The Fed will announce its purchases one day after the nation votes for a new Congress. High unemployment, meager wage gains and soaring home foreclosures have frustrated many voters. Republicans are expected to score big gains.

The anticipated move by the Fed has sharply divided economists, according to an AP Economy Survey released last week. Roughly half said such bond purchases, if they reduced rates, could spur Americans to spend more, strengthen the economy and lead to more hiring.

But the other half countered that another round of stimulus won't provide much help. Some worry it could lead to new threats later on. These include out-of-control inflation or a wave of speculative buying that inflates bubbles in the prices of commodities or bonds or other assets.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, and other "inflation hawks" share those concerns. At each meeting this year, Hoenig has opposed the Fed's pledges to keep rates at record lows and other efforts to energize the economy. He's likely to oppose the new aid program.

[Associated Press; JEANNINE AVERSA]

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