Fed Signals New Concerns on Economic Growth With Debt Move

We started this day by saying markets, investors, economists and politicians were watching the Fed’s actions Tuesday to see just how worried Chairman Ben Bernanke and his colleagues are about the state of a sluggish economy.

The answer came this afternoon: Increasingly worried. In fact, concerned enough to signal the Fed is prepared to take a more active role in the months ahead with an economy that is weaker than the Fed itself had predicted. But not so alarmed that it needed to take major steps yet.

In a statement released early this afternoon, Fed officials said they will begin buying some government debt — in this case Treasury securities — at a small level “to help support the economic recovery.”

The amount — roughly $10 billion a month according to some reports — would come from investments or proceeds made from mortgage bonds bought by the Fed since 2009. The Fed bought more than $1.7 trillion in mortgage-backed securities and Treasury debt in the aftermath of the financial crisis to help stabilize banks, credit and markets.

While $10 billion a month sounds small by comparison, Laurence Meyer, a former member of the Fed’s Open Market Committee (FOMC), told us, “I don’t think the actions were small. It’s quite a powerful signaling device.

“I think we certainly know from this that a renewal of long-term asset purchases by the Fed is on the table,” said Meyer, now a senior managing director at MacroEconomic Advisors.

Others said the action was small at this point, but agreed that the Fed could be opening the door to taking a more significant role again by buying debt to ease credit conditions and help spur lending.

“It’s not huge, it’s moderate,” said Brian Bethune, chief U.S. financial economist for IHS Global Insight. “But I would say it’s bigger than most people think.”

“They’re trying to keep us from sliding into a deflationary environment,” he said. “I would say they see it (deflation) as an issue but they don’t see it as an imminent danger.”

The most immediate impact of today’s decision to buy Treasury securities, Bethune said, “will translate into lower mortgage rates across the board.”

The Fed, says Meyers, is suggesting it’s moving from worries about the prospect of inflation and whether it needs to raise interest rates to “showing there’s an equal chance they will go in the other direction.”

In a statement issued by the Fed’s Open Market Committee — the committee that makes decision about interest rates and monetary policy — members said, “the pace of recovery in output and employment has slowed in recent months. … Housing starts remain at a depressed level. Bank lending has continued to contract.”

Economists say that’s part of the reason the Fed will buy assets again.

“Should the economy not respond to the action taken by the Fed over the past two months,” Bethune wrote, “the FOMC could entertain an outright increase in the size of its balance sheet of several hundred billion dollars at the September or November meetings”

Fed officials also said in the statement that they expected economic growth to continue but “more modest in the near term than had been anticipated.”