Fed creates US history as it maps new strategy

By Craig Torres  |   2008-12-18  |     NEWSPAPER EDITION

THE Federal Reserve opened a new era in United States monetary history, cutting interest rates to as low as zero and pledging to buy unlimited quantities of securities, after conventional policies failed to arrest what may be the worst recession since World War II.

The new strategy is likely to involve unusually close cooperation with the Treasury of President-elect Barack Obama, which is still formulating its economic-rescue plans. The aim is to kick-start borrowing and spending to propel the economy toward a recovery by the middle of next year, Bloomberg News said.

"It's going to take a combination of fiscal and monetary stimulus to get the job done," said former Fed Governor Lyle Gramley, now senior economic adviser at Stanford Group Co in Washington. The central bank has signaled it will "make sure that the fiscal stimulus package, which is going to be a big one, is fully supported" and "in effect financed by the Fed."

Possible steps by the Fed in coming months include financing for a new package to shore up the housing industry, and expanding a US$200-billion program to undergird credit card and student loans. The new plan is risky: market pricing could be distorted for months or years, with insolvent borrowers kept afloat as central bankers force yields below levels investors deem appropriate given the risks.

The Fed's Open-Market Committee on Tuesday said it will use "all available tools" to generate a resumption in growth. The FOMC also effectively retired its benchmark interest rate, bringing the target for overnight loans between banks down to 0 to 0.25 percent from 1 percent previously.

Stocks surged as the clarity of the Fed's commitment exceeded some investors' forecasts. Treasuries jumped in anticipation of Fed purchases, and mortgage bonds rallied. The Standard & Poor's 500 Stock Index rose 5.1 percent to a five-week high. Benchmark 10-year note yields fell more than a quarter point, to 2.26 percent.