Business

US Federal Reserve takes step to boost recovery

  • 10 August 2010
  • From the section Business
US Federal Reserve chairman Ben Bernanke
The Fed said economic recovery was likely to be "more modest" in the short term

The US Federal Reserve has taken a step towards boosting economic recovery, by saying it will use proceeds from its investments in mortgage securities to buy longer-term government debt.

The move means that it will maintain the size of stimulus spending programme, pumping in money to try to bolster the economy.

The Fed warned that the pace of recovery had slowed in recent months.

It also kept interest rates unchanged at between zero and 0.25%.

There had been speculation that it would signal it was restarting, or expanding, the "quantitative easing" (QE) scheme. Commentators dubbed this latest move "QE lite".

Stock markets recovered some of their earlier losses after investors reacted positively but still cautiously to the news.

The Dow Jones index, down about 100 points before the Fed announcement, was only 15 points lower shortly afterwards. It closed down 54 to 10,644.

US government bond prices also rose.

There are fears among some, including former chairman of the US Federal Reserve, Alan Greenspan, that the US economy could be heading towards a double-dip recession.

Constraints on spending

The Fed had hoped to scale back the amount of money it put into the economy as it saw a recovery.

But as the pace of the early recovery has slowed, it will keep its $2.3 trillion (£1.45tn) balance sheet steady by reinvesting repayments on debt and mortgage-backed securities into Treasury bonds.

The crisis saw an unprecedented expansion in its balance sheet as in injected new money into the economy. Before then its balance sheet was about $800bn.

In a statement, the Fed said the pace of recovery had slowed in recent months and is likely to be "more modest in the near term than had been anticipated".

"Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit," the central bank said.

Some analysts say the move could mean that money can be borrowed cheaply for a longer period of time.

"The Fed's investments in longer-dated Treasury debt should... lower mortgage and other borrowing rates," Stephen Gallagher and Aneta Markowska from Societe Generale commented.

Others believe the Fed will have to take further steps in the coming months.

"The Fed is a step closer to reviving its [full QE] programme, but it will likely take somewhat slower growth to push it off the fence," said Sal Guatieri, senior economist at BMO Capital Markets.

Figures from the US Labor Department also showed that US business productivity fell by an annual rate of 0.9% in the second quarter.

It was the first time since the fourth quarter of 2008 that output per worker had fallen, and comes after productivity had risen by 3.9% rate in the first quarter of this year.

'Credit easing'

During the financial crisis the Federal Reserve introduced a number of new tools to inject new money into the economy.

Fed chairman Ben Bernanke dubbed the process "credit easing" as opposed to "quantitative easing" and divided the central bank's policy tools into three main areas.

These were - lending to financial institutions, providing liquidity to key credit markets, and purchasing long-term Treasury securities.

Mr Bernanke has said the US approach differs from a straightforward QE regime, "where the focus of policy is the quantity of bank reserves" rather than targeting the mix of loans and securities held by the central bank.

Related Internet links

The BBC is not responsible for the content of external Internet sites