Fed Mulls New Tool in Bond Buying Program

by Reese Darragh on March 8, 2012

Officials at the Federal Reserve are considering a new tool to be used in their bond purchasing program to offset worries over future inflation should they decide to take new steps to boost the economy in months ahead.

The new approach will see the Fed printing new money to buy long-term mortgage or Treasury bonds but tie up the money by borrowing it back for short periods at low interest rates. The purpose of the approach will be to relieve worries over inflation fuel by the money printing exercise, a fear widely expressed by critics.

Per The Wall Street Journal report, officials are set to meet next week and have signaled that they are unlikely to launch new programs at the meeting. It is also said that the Fed officials seem unlikely to launch a bond buyback program if the economy does not need the extra help or if it is at risk of higher inflation. However, if growth disappoints or inflation slows substantially, Fed officials might at some point decide to act again.

Fed officials have used different types of bond buying programs since 2008 to lower long-term interest rates to spur investment and spending by businesses and households. People familiar with the matter said if the Fed decides to act again, they will be exploring three different approaches including:

1. Printing money and used it to purchase Treasury securities and mortgage debt – an approach used from 2008-2011. Fed has acquired more than $2.3 trillion securities through their quantitative easing (QE) approach.

2. Selling short term Treasury securities and using the proceeds to buy long-term bonds – a method used last year. The $400 billion program also known as Operation Twist allows the Fed to buy bonds without creating new money.

3. The new approach to print money to buy long term bonds but restrict how investors and banks can use the money by employing new market tools to better manage cash injected into in the financial system, also known as sterilized QE.

The difference between the three approaches involves where the money comes from and where it ends up. The Fed has so far injected more than $1.6 trillion in new money into the financial system by electronically crediting the accounts of banks and investors with new money when it purchased their bonds under the QE program.

Many Fed officials believe that the bank reserves created as part of this money creation exercise are not an inflation threat. However, a popular perception is that the money could cause an inflation problem in the future.

Reese Darragh is a contributing writer for CompliancEX and Wall Street Job Report. She is an experienced business news writer with expertise in macroeconomics topic, the financial industry, rules and regulations including the Dodd-Frank Act and the Sarbanes-Oxley Act as well as rules from other federal regulators. She has a Master Degree in International Economics and Finance from Brandeis University.

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