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Fed’s treasury-bond gambit: mother of all rescue plans

As much as $1 trillion will lower long-term loan rates like mortgages but it raises the specter of inflation.

By Staff writer / March 19, 2009

Traders watched the Fed announcement on the floor of the New York Stock Exchange on Wednesday. The Nasdaq and the S&P 500 shot up, while the Dow Jones Industrials turned positive after the Federal Reserve said it would buy long-term US Treasuries in its push to revive the recession-hit economy.

Brendan McDermid/Reuters

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The Federal Reserve’s unexpected move this week to pump as much as $1 trillion of new money into the economy is being hailed by some analysts as the move “most likely to succeed” in lifting America out of recession. It promises to affect Americans in numerous ways – lowering interest rates on mortgage loans and small-business borrowing.

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The Fed’s plan is to purchase massive quantities of Treasury bonds and mortgage-related securities in a bid to bring the cost of credit down for ordinary borrowers, and to keep it down for an extended period.

Early reactions were positive: Stock prices rose, Treasury borrowing costs plunged, and mortgage rates fell. But the action is not without risks both to inflation and financing future US debt.

The value of the dollar sank on foreign-exchange markets and commodity prices rose in response – signs that the Fed could lose control of inflation down the road, and make foreign investors less willing to buy America’s debt. But many forecasters say the Fed’s move boosts the prospects for an economic recovery later this year.

“Of all the things that Washington has put together to get us out of this financial mess, I think what happened Wednesday is probably the most important,” says Ed Yardeni, an economist who heads Yardeni Research in Great Neck, N.Y. “This affects so many people.”

But markets have shown that the Fed’s attempts to energize the economy don’t always work as intended. The Fed has already slashed its own short-term interest rate virtually to zero during the past year and has introduced a range of large, innovative programs to get credit flowing again. Yet turmoil in credit markets has persisted, and job losses have mounted.

One forward-looking gauge of economic activity, the index of leading indicators, fell by 0.4 in February, the Conference Board reported Thursday.

Still, the new moves, supported by a unanimous vote of the Fed’s policymaking committee, suggest a renewed commitment to open floodgates of liquidity as needed to end an unusually deep and long recession. In sheer dollars to be deployed, some economists also say it’s the largest-scale effort to date – by the Fed or the White House and Congress.

“This trumps any of the other plans,” Yardeni says.

The Fed said it will:

•Purchase as much as $300 billion of longer-term Treasury securities during the next six months.

•Buy an additional $750 billion of mortgage securities, bringing its purchases of these securities to up to $1.25 trillion this year.

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