EXCERPTS:
"The Federal Reserve, facing an economic recovery that it termed "more modest" than anticipated, said Tuesday it will stop shrinking its huge portfolio of securities by reinvesting the proceeds of maturing mortgages in U.S. Treasury debt.
The Fed move is largely symbolic and is unlikely to stimulate the economy significantly. But the shift in the management of its portfolio—and an accompanying statement—underscored Fed officials' concern about the vigor of the economic recovery. It also opens the door for bigger purchases of Treasurys or other securities should the economy falter or the risk of deflation grow, though the hurdle for such action remains high.
Downgrading its assessment of the economy, the policy-making Federal Open Market Committee said the recovery "has slowed in recent months," and that the "pace of economic recovery is likely to be more modest in the near term than had been anticipated." The committee repeated its commitment to keep its target for the federal funds rate, at which banks lend to each other overnight, at "exceptionally low levels" for an "extended period."
The Fed noted that high unemployment, modest income growth, lower housing wealth and tight credit were holding back household spending. Meanwhile, lending by banks "has continued to contract," the Fed said, while construction remains weak and employers remain reluctant to increase payrolls.
After cutting short-term interest rates nearly to zero in December 2008, the Fed essentially printed money to expand its portfolio of securities and loans to above $2 trillion, from $800 billion before the global financial crisis. Its purchases of mortgage-backed securities and U.S. Treasury debt, aimed at keeping long-term interest rates down, were discontinued in March. The Fed began talking about an "exit strategy" from the unprecedented steps it took to prevent an even deeper recession.
But on Tuesday, the Fed shifted its stance. It said it would act to keep its securities holdings constant at around $2.054 trillion, the level on Aug. 4. Had the Fed not acted, its mortgage portfolio was set to shrink by $10 billion to $20 billion a month, as mortgages matured or were paid off early. Now, the Fed will reinvest those proceeds in U.S. Treasury securities of between two- and 10-year maturities.
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The Fed statement noted that "measures of underlying inflation," already low, "have trended lower" lately and are "likely to be subdued for some time." Some Fed officials, as well as private economists, have been warning that the risk of deflation—broadly falling prices and wages across the economy—is rising. A Wall Street Journal survey of economists, mostly from Wall Street, found this week that, by a two-to-one margin, they see deflation as a greater risk over the next three years than inflation.
With interest rates as low as they can go, the Fed has few attractive options to resist deflation. The main one is to print money—electronically—to resume large-scale purchases of securities.
