While former Fed Chairman Alan Greenspan goes to the press in defense of his reputation, the Wall Street Journal's Greg Ip gets practical, talking about the Federal Reserve's options as the current credit crunch deepens.Cut the Fed Funds Rate? Well, that benchmark rate is down 3 percent since September 2007 and now sits at 2.250%. That hasn't seemed to right the ship, though, because we're all still talking about recession.
Today, just in time for the Fed's upcoming meeting, Ip's piece in the Wall Street Journal gives an interesting look at some oft-ignored tools in the Federal Reserve's toolbox.
The Fed's stated mission is to provide stability and flexibility to the U.S. monetary system and there are a several unusual-but-worthy tactics to move towards that goal:
Pay interest to banks for their money on deposit with the Fed. Currently, the Fed does not pay interest on bank reserves but a new law changes this in 2011. The Fed may petition to have that law enacted sooner.
Issue debt under the Federal Reserve's name instead of the U.S. Treasury Department.
Print more money. This would push short-term rates lower and destroy the dollar. Business exporters and foreign national buyers of real estate are two groups that would benefit.
Cutting the Fed Funds Rate make debt less expensive in the United States. It increases spending and fuels economic growth. However, cuts to the Fed Funds Rate are ineffective if confidence is waning and that is what we're seeing today.
It's also why mortgage rates are trending lower -- investors are seeking safety from an uncertain economy and parking their money in bonds.
The Fed meets again April 29 for a 2-day meeting and will likely take its "next step" prior to the meeting's commencement. If investors deem the Fed's actions effective, it should spark confidence in the economy and that will cause money to flow back into stocks at the expense of bonds.
Less demand for bonds makes mortgage rates rise.
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