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What's Next? Some Options Available for the Fed

April 25, 2011 (Associated Press) WASHINGTON - Federal Reserve officials are expected to signal this week that their $600 billion Treasury bond purchase program will end in June as planned. Now, the debate shifts to the Fed's next potential moves.

Here are options for the Fed under different economic scenarios.

If policymakers grow fearful about the prospect of runaway inflation:

- The Fed could raise the rate it charges banks for emergency loans. That rate, called the discount rate, is 0.75 percent. An increase in the discount rate wouldn't directly affect interest rates charged to consumers and businesses. But it would be viewed as a signal that those rates will soon rise.

- The Fed said last year that it will likely start to tighten credit by boosting the rate it pays banks on money they leave at the central bank. Doing so would raise rates tied to commercial banks' prime rate and affect many consumer loans. The rate paid on banks' excess reserves is 0.25 percent. Boosting that rate would give banks an incentive to keep money at the Fed rather than lend it.

Tightening credit by adjusting the rate it pays on banks' excess reserves would be a new strategy for the Fed. Since the 1980s, its main lever to adjust credit has been the federal funds rate. That's the rate banks charge each other for loans. It's now at a record low near zero.

Setting interest rates through the excess reserves rate gives the Fed more control over money floating through the financial system. The Fed sets that rate directly. By contrast, its federal funds rate is merely a target.

For consumers and businesses, a shift in which tool the Fed uses to tighten credit would make little practical difference. A bump-up in either the rate on excess reserves or the federal funds rate would have an identical result: It would boost the prime lending rate, now at 3.25 percent, by the same amount.

- Other options include: Selling securities from the Fed's portfolio, with an agreement to buy them back later. Those operations are called reverse repurchase agreements. Or the Fed could sell securities outright. Those moves would tighten credit by mopping up some of the money that was pumped into the economy during the financial crisis.

If Fed policymakers become concerned about a weakening economy:

- Embark on a third round of stimulus, probably by buying more Treasury bonds. The goal would be to lower rates on loans and push up stock prices. That could spur spending and invigorate the economy.

Copyright 2011 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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