Fed presses on into uncharted territory

John W. Schoen Senior producer • Profile • E-mail

The Federal Reserve's decision to cut its target for short-term interest rates to as low as zero reflects the reality of a central bank scrambling to apply a new  set of monetary tools to battle the deepening recession.

“These are extraordinary times that call for extraordinary measures,” said Robert McTeer, former president of the Dallas Federal Reserve Bank.

In an unprecedented move, Fed Chairman Ben Bernanke and his colleagues Tuesday set a new target range for overnight lending between banks at zero to 0.25 percent, down from the previous target of 1 percent.

The decision was just one of several bold and unexpected steps announced by the Fed. In an unusually extensive statement, the central bank acknowledged that the weakening economy called for an expanded range of responses and pledged to use “all available tools” to get growth back on track.

Those tools include an aggressive buying spree of public and private debt securities that the central bank began in September. The Fed reiterated Tuesday that it intends to buy “large quantities of agency debt and mortgage-backed securities” and announced that it is considering buying longer-term Treasury securities. In addition the Fed will consider other “ways of using its balance sheet to further support credit markets and economic activity.”

Over the past three months of financial crisis, the Fed has unveiled an alphabet soup of new programs — from the Term Auction Facility to the Commercial Paper Funding Facility — with one common goal: buying up debts that no one else wants and swapping them for cash.

Those efforts to flood the financial system with cash have been far more important than the rate-setting that is usually the Fed's most effective tool. The Fed's decision to announce a target range of zero to 0.25 percent is an acknowledgement that the central bank has been unable to meet its stated target rate through normal purchase and sale of Treasuries in the open market.

Although the Fed has had a target of 1 percent since Oct. 29, the actual market-based rate has fallen as low as 0.125 percent in recent weeks due to slack demand for short-term borrowing.

With short-term interest rates effectively at zero, the Fed can do little more to lower the cost of borrowing. The hope is that by pumping trillions of dollars of cash into the credit system by buying up securities, that money will find its way into the hands of cash-strapped consumers and businesses to help revive the economy.

With more than a half million jobs lost in November alone, the government provided fresh data Tuesday on just how much deeper the recession has become.

Shrinking demand sent consumer prices last month on their biggest slide since records were first kept 61 years ago, the Labor Department reported. Prices fell 1.7 percent, due largely to the deep slide in energy costs.

In a separate report, the Commerce Department reported that construction of new homes fell in November by 18.9 percent, the biggest drop in a quarter-century. The decline pushed construction down to a seasonally adjusted annual rate of 625,000 homes, the slowest pace on records dating to 1959.

Now as banks, companies and consumers all struggle to pay down a mountain of debt taken on during the easy-money years of the first half of the decade, spending and investment have slowed to a crawl and new credit has dried up. To fill the hole created by that huge private sector debt, the Fed is now taking unprecedented levels of debt onto its own books, and swapping that debt for cash to try to get money flowing normally again through the financial system.

“We're in a change in regime in terms of policy, where the focus is switching away from the federal funds rate to other actions the Fed can take with its balance sheet to improve financial conditions and encourage the flow of credit,” said former Fed Gov. Laurence Meyer, now vice chairman of Macroeconomic Advisers.

With short-term interest rates already close to zero, the Fed has been moving to a strategy known as “quantitative easing” — essentially dumping money into the economy to make credit easier to get. Early in his tenure as a board member, Fed Chairman Ben Bernanke described the policy by likening it to dropping money from a helicopter, a speech that earned him the nickname “Helicopter Ben.”

“The (target interest) rate is the least important issue right now,” said Diane Swonk, chief financial officer of Mesirow Financial. “It will be the alternative actions — the helicopter in the sky and how much money they're going to drop from the helicopter.”

MORE FROM EYE ON THE ECONOMY

Eye on the Economy Section Front

NYT: U.S. forecasts smaller loss from bank bailout Obama talks of jobs plan in weekly address Productivity rises by largest amount in 6 years Bleak job scene poses challenge for Obama 'Problem' banks at highest level in 16 years RV industry no longer running on empty Long-term unemployed face dwindling options  Obama warns of 'double-dip recession' One in four metro areas in recovery mode Geithner warns lack of loans may slow recovery Eye on the Economy Section Front   Add Eye on the Economy headlines to your news reader: