Fed Mulls New Bond Approach

Federal Reserve officials are considering new tactics for the purchase of long-term U.S. Treasury securities to bolster a disappointingly slow recovery.

Jon Hilsenrath discusses the likelihood that the Federal Reserve will act gradually if it decides to act again to stimulate the economy.

Rather than announce massive bond purchases with a finite end, as they did in 2009 to shock the U.S. financial system back to life, Fed officials are weighing a more open-ended, smaller-scale program that they could adjust as the recovery unfolds.

The Fed hasn't yet committed to stepping up its bond purchases, and members haven't settled on an approach. After its meeting last week, the Fed's policy committee said it was "prepared" to take new steps if needed.

A decision on whether to buy more bonds depends on incoming data about economic growth and inflation; if the economy picks up steam, officials might decide no action is needed.

The Fed's internal debate about a bond-buying strategy is emblematic of the challenging position in which it finds itself. In normal times, it simply raises or lowers short-term interest rates to guide the economy.

But having pushed short-term rates to near zero, it now has to devise new, untested approaches at almost every turn. A misstep could lead to unintended consequences, one factor that makes officials wary and investors jittery about its every move.

In theory, buying long-term bonds pushes other interest rates down because it reduces the supply of debt available to investors, pushing up the price of this debt and the yield down.

In March 2009, the Fed said it would buy $1.7 trillion worth of Treasury and mortgage-backed securities over a six to nine month period—known inside the Fed as the "shock and awe" approach.

Most Fed officials believe that helped to drive down long-term interest rates and spurred the economy.

Under the alternative approach gaining favor inside the Fed, it would announce purchases of a much smaller amount for some brief period and leave open the question of whether it would do more, a decision that would turn on how the economy is doing. This would give officials more flexibility in the face of an uncertain recovery......