Financial Times - March 25, 2002
Fed considered emergency measures to save economy The minutes of a January FOMC meeting suggest using 'unconventional' methods to stop interest rates becoming an ineffective monetary policy tool
By PERONET DESPEIGNES
The US Federal Reserve in January considereda variety of "unconventional" emergency measures to be taken if cutting short-term interest rates failed to arrest a US recession and prevent Japanese-style deflation. One of those steps may have been a plan to buy US stocks.
According to minutes of its January 25-26 meeting, the Fed's policy-making Open Market Committee agreed "unconventional policy measures might be available" to deal with a situation in which "the economy were to deteriorate substantially in a period when nominal short-term interest rates were already at very low levels", although, it said, the efficacy of such measures was "uncertain". The minutes vaguely mention internal analyses of such a scenario.
The discussion appeared largely academic, conducted at a time when the year-long recession was drawing to a close. But the topic was apparently brought up in the context of concerns that the US could have faced - and might face in the future - a dilemma in which short-term interest rates were so low as to be rendered ineffective as a monetary policy tool.
Minutes which summarised the meeting were released last week. A full transcript will not be available for five years but a senior Fed official who attended the meeting said the reference to "unconventional means" was "commonly understood by academics". The official, who asked not to be named, would not elaborate but mentioned "buying US equities" as an example of such possible measures, and later said the Fed "could theoretically buy anything to pump money into the system" including "state and local debt, real estate and gold mines - any asset".
The Fed currently relies on the buying and selling of Treasury bonds as a way of targeting short-term interest rates.
In its fight against the economic downturn, the Fed has reduced the Fed funds rate from a 10-year high of 6.5 per cent to a 40-year low of 1.75 per cent. The moves prompted speculation last year among some economists that short-term interest rates might at some point hit zero and that interest-rate policy might become useless.
The minutes said FOMC members agreed this scenario was "highly remote, but could not be dismissed altogether".
While not mentioned in the minutes, Fed officials appeared to have in mind the example of Japan, an economy mired in a decade-long slump. Deflation - or falling prices - and other problems have led the central bank to cut short-term interest rates to practically zero.
The minutes said Fed officials considered a similar US scenario and concluded: "If in the future such circumstances appeared to be in the process of materialising (in the US), a case could be made at that point for taking pre-emptive easing actions, to help guard against the potential development of economic weakness and price declines that could be associated with the so-called 'zero bound' policy constraint.
"This "zero bound" scenario - in which the Fed funds rate would hit zero - has been discussed before by policymakers as the Fed has succeeded in driving inflation to 30-year lows. But talk of "unconventional policy measures" has never appeared in FOMC minutes.