Fed readies plan to combat economic nosedive
By Martin Crutsinger
Associated Press
WASHINGTON — Confronting new fears of recession, the Federal Reserve is refining an emergency economic rescue strategy that includes further interest rate cuts and billions of dollars in extra cash for the banking system.
The Fed's effort would be aimed at pulling the country out of a nosedive that has seen 465,000 jobs evaporate in the past two months, raising fears among economists that the weak recovery from the 2001 recession is in danger of stalling out altogether.
"Clearly, the Fed is in uncharted territory," said economist David Jones. "I think they will try some experimental moves."
Based on comments by Federal Reserve Chairman Alan Greenspan and other Fed officials, the central bank is signaling that it is poised to move beyond its traditional buying and selling of short-term Treasury securities to the direct purchase of longer-term securities in an effort to pump more money into the banking system and influence long-term interest rates.
Also, Fed officials have indicated they are prepared in the event of an unexpected shock to the system to lend massive amounts of money directly to commercial banks to make sure financial markets do not freeze up.
And as a third policy option, Fed officials have indicated they would explicitly state that if the federal funds rate is moved below its current 41-year low of 1.25 percent, it is likely to stay at the lower level as long as needed to get the economy on its feet — which would help ease investors' worries about a sudden jump in interest rates down the road.
Fed officials being so open in discussing these options underscores the need the central bank sees to restore investor confidence that has been shaken by the failure of the Fed's aggressive two-year campaign to cut short-term rates to produce a sustainable economic recovery.
Greenspan in a speech in December in New York noted that the Fed from 1942 to 1951, as part of an agreement with the White House, successfully capped long-term Treasury yields at 2.5 percent as a way to hold down borrowing costs to finance World War II.
However, private economists note that a later Fed effort dubbed "Operation Twist" — in which the central bank sold short-term Treasury securities and bought long-term securities in the early 1960s in an effort to influence rates at both ends of the yield curve — was judged to be a failure because the central bank did not make the transactions in large enough amounts.
"If you want to produce results, you have to convince markets that you are serious and will do whatever it takes to alter the rate structure," said former Fed board member Lyle Gramley.
The Fed made just such a massive response on Sept. 12, 2001, the day after the terrorist attacks, when it lent a record $46 billion to banks in a single day to keep the financial system functioning.
Fed officials have indicated their battle plan has been influenced heavily by reviewing the mistakes made by the Bank of Japan, which has been unable to jump-start that country's economy over a decade despite driving short-term interest rates to zero.
Vincent Reinhart, the Fed's top monetary policy staffer, told an economic conference recently that the Fed is striving to act pre-emptively before falling prices become entrenched.
Because of this, some economists believe the Fed will not wait until its May 6 meeting to put its plan into effect, opting to cut the federal funds rate through an emergency conference call, possibly as soon as this week.
However, other analysts argue that the Fed will likely wait, hoping that U.S. advances in the war against Iraq will bolster markets in coming weeks and restore confidence.
