WASHINGTON – When the Federal Reserve holds a policy meeting Tuesday and Wednesday, it's widely expected to adopt some new step to boost the economy. The question is what it will be.
Whatever the Fed does will likely be intended to drive down long-term interest rates to encourage borrowing and spending and lift stock prices. The idea is that all of that would combine to help raise economic growth and hiring.
The move that's considered most likely is for the Fed to adjust the makeup of its $1.7 trillion portfolio of Treasury securities. The Fed would sell some shorter-term Treasurys. And it would use the proceeds to buy longer-term Treasurys. That shift could drive down long-term rates, which affect rates on mortgages and other loans.
The central bank is weighing unusual steps because the economy is struggling to grow, and the Fed's main policy lever, the federal funds rate, is already near zero. The funds rate is the rate banks charge each other on overnight loans,
Investors have been anticipating action out of this week's meeting, in part because Chairman Ben Bernanke said in August that the September policy meeting would take two days, rather than one, to give Fed members more time to discuss their options.
"If they weren't going to do anything, then I think they would have tried to deflate expectations by now," said David Wyss, former chief economist at Standard & Poor's and now a visiting fellow at Brown University.
Here's a look at the Fed's options:
— ADJUSTING ITS PORTFOLIO
This is the move that most analysts expect to be announced when the Fed's meeting ends Wednesday. It's been dubbed "Operation Twist," after a similar move taken in the early 1960s when Chubby Checker's version of "The Twist" was the rage. The Fed tried to "twist" rates to lower long-term rates relative to short-term rates.
Anticipation that the Fed will adopt some form of Operation Twist, combined with sour economic news, has helped push down the rate on the 10-year Treasury note to 1.95 percent. In July, the rate exceeded 3 percent.
Some economists think such action could lower the 10-year rate by an additional quarter-point. On the other hand, should the Fed decide not to take this step, long-term rates might head higher.
Operation Twist has the advantage of potentially lowering long-term rates without expanding the Fed's already record-high portfolio of securities. The Fed will eventually need to shrink its portfolio.
Still, critics caution that by lengthening the average maturities of its holdings, the Fed might make it harder to wind down its portfolio without pushing rates up again.
— MORE BOND PURCHASES
The Fed could announce a third round of bond buying, a step known as quantitative easing. This would probably be the most dramatic move it could make. Economists think it's unlikely, in part because of heavy criticism the second round of bond buying evoked from some. Critics warned that the purchases raised the threat of inflation, weakened the dollar's value and contributed to a spike in prices of oil and other commodities.
Republican presidential candidate Gov. Rick Perry of Texas has said it would be "almost treasonous" for Bernanke to launch more bond buying.
On Aug. 9, the Fed said it planned to keep short-term rates at record lows until at least mid-2013, assuming the economy remained weak. That statement drew three dissenting votes inside the Fed — the most in more than two decades. Bernanke could face even stiffer resistance to a new bond-buying program.
— WORDING CHANGE
The Fed could provide further guidance on future action. Such a move is being urged by Charles Evans, president of the Federal Reserve Bank of Chicago.
Evans has suggested that the Fed commit to keeping rates low until unemployment, now 9.1 percent, drops to 7.5 percent or lower — as long as "core" inflation doesn't exceed 3 percent. Core inflation excludes volatile food and energy prices.
That commitment could reassure investors that rates would remain low well into the future. But this idea would likely ignite opposition from some Fed regional bank presidents who worry that Fed policies have already raised the risk of high inflation once the economy gains momentum.
— INTEREST ON RESERVES
Another option Bernanke raised in testimony to Congress in July was to reduce the 0.25 percent interest the Fed pays banks on their excess reserves. The thinking is that cutting that rate would reduce the incentive for banks to keep their money at the Fed. So they might lend more.
Yet economists say the availability of credit isn't the main reason for low levels of lending. Rather, it's weak consumer and business confidence, which has cut demand for loans. They say that reducing the already tiny interest rate on banks' reserves would have a negligible effect on lending.
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