The Fed’s toolkit: depleted but not empty

A sharp slowdown in U.S. growth has raised speculation the Federal Reserve may have to provide additional monetary support to the economy. With interest rates already effectively zero and the Fed’s balance sheet at a record $2.85 trillion, U.S. central bank officials are reluctant to take further steps to stimulate economic activity. Still, persistent unemployment and fresh turbulence in financial markets could boost the pressure on the Fed to do something. No concrete action is expected at an upcoming meeting on Tuesday, but officials could acknowledge growth forecasts made in June now look overly optimistic.

The bank’s policy arsenal is depleted but not completely empty. Fed Chairman Ben Bernanke testified last month that the Fed was prepared to respond to possible further weakness. Here are some of the measures he said are still available to the Fed:
BOLSTER EASY POLICY ASSURANCES
The Fed has already promised to hold benchmark interest rates extraordinarily low for an extended period. It could bolster that commitment by extending the pledge to the securities holdings acquired through unconventional monetary policy. Or it could pledge to hold rates near zero until a specific date beyond the timeframe currently expected by markets.
BOND BUYS
New purchases of long-term Treasury assets is seen as a possibility. The Fed believes its two rounds of bond-buying have held longer-term rates down and encouraged investors to move into riskier assets, helping drive the stock market higher. The Fed could also increase the average maturity of its securities holdings to put further downward pressure on long-term borrowing costs.
LOWER THE INTEREST RATE ON EXCESS BANK RESERVES
The Fed could lower the 0.25 percent interest rate it currently pays banks on excess reserves held at the Fed. Doing so could encourage banks to put those reserves to use by lending them out. But Bernanke has said the likely impact of moving this already low rate even lower would be marginal.
RAISE THE FED’S INFLATION TARGET

By temporarily setting a target for inflation above what the Fed considers consistent with long-term price stability, the Fed would again be communicating to markets that any tightening of monetary policy is far off. However, Bernanke has made clear this was a highly controversial proposition within the Fed and is an unlikely course of action. He did not mention this possibility in his most recent remarks on possible easing tools. -Reuters