Factbox: What tools does the Fed have to spur growth?

(Reuters) - With unemployment stuck above 8 percent and the threat that the European crisis or looming U.S. fiscal squeeze could tip the economy into recession, the chances for fresh stimulus from the Federal Reserve appear to be rising.

Many Fed policymakers think further easing would be warranted "fairly soon" unless the economy improves, minutes of their July 31-August 1 meeting show.

The Fed cut benchmark short-term interest rates to near zero almost four years ago.

In addition, it bought $2.3 trillion in bonds to push down longer-term borrowing costs, has pledged to hold rates exceptionally low until at least through late 2014, and has been exchanging shorter-dated securities in its portfolio for longer-term ones to drive down interest rates.

Traders peg the Fed's first rate hike as most likely coming in December 2014, based on fed funds futures contracts.

Fed Chairman Ben Bernanke addresses fellow policymakers in Jackson Hole, Wyoming on Friday.

Following is a menu of Fed options:

BUY MORE BONDS

The Fed could decide to expand its $2.85 trillion balance sheet further with more purchases of Treasury or mortgage bonds, or perhaps a mix of both. The Bernanke Fed has twice before embarked on large-scale asset buying sprees known as quantitative easing. Some policymakers expressed support at the most recent policy meeting for a "flexible" program that does not specify a fixed dollar amount of purchases but instead allows the central bank to buy more or less as needed.

Benefits: QE3 is likely the most powerful tool the Fed has and financial markets and the public are familiar with it. Bernanke and others argue the first two rounds effectively lowered rates on 10-year Treasuries and other bonds, shifted investors into riskier assets and gave stock markets a boost.

Risks: While Fed officials say they could unwind the massive balance sheet before inflation takes off, it has never been done on such a scale before. Conservative lawmakers have urged the Fed to refrain from further quantitative easing, saying it risks inflation and enables Congress and the president to avoid dealing with looming fiscal problems. In addition, Fed officials admit there are limits to how many bonds they can buy before they corner so much of the market that market functioning is impaired.

EXTEND RATE PLEDGE OR OTHER COMMUNICATIONS

The Fed has said it expects economic conditions to warrant keeping rates "exceptionally low" at least through late 2014. According to minutes of the July 31-August 1 meeting, many members of the Fed's policy-setting panel support pushing that date out further, although they deferred any action until September.

Benefits: This would not entail the risks or likely controversy surrounding QE3. Pushing the date of the first likely rate hike into 2015 or beyond could help lock in current expectations or move them out further.

Risks: Changing the rate pledge may not deliver the sort of psychological boost the Fed might hope. Also, the farther into the future the Fed pushes the date, the less believable it is, in part because it is unclear whether Bernanke, whose term expires in January 2014, will still be Fed chairman at whatever date the pledge stretches to.

CUT INTEREST ON RESERVES

The Fed pays banks 0.25 percent interest on reserves they hold at the central bank. Cutting this rate could force banks to lend.

Benefits: This would be a gentle prod to lenders and is a ready tool at the Fed's disposal to take advantage of the massive amounts of reserves the central bank has created by expanding its balance sheet. The European Central Bank appears to have gained some benefit from a comparable measure.

Risks: Lowering rates from 0.25 percent would be too small of a change to make much of a difference, New York Fed economists said in a research paper. Some also worry that lowering this rate could disrupt money market mutual funds, which might have difficulty operating if rates were closer to zero.

USE THE FED'S DISCOUNT WINDOW

Bernanke has cited the Fed's discount window as a possible tool for further Fed easing.

The discount window, which is where deposit-taking banks can borrow when they can't obtain funding anywhere else, had not previously been seen as among possible tools for a further easing of monetary policy. Banks shy away from borrowing at the discount window out of fear they will be seen as weak if they cannot get the funds they need in the market. While the Fed has kept overnight interbank borrowing costs near zero, it is currently charging 0.75 percent for discount window loans -- an effort to ensure it is not subsidizing banks.

It is unclear how the Fed would use the discount window to boost growth, although there is some speculation it might try to craft a program that gives banks an incentive to lend.

The Bank of England recently announced a program to provide inexpensive funds to banks provided they go to households and businesses, and at the most recent policy meeting a couple of Fed officials expressed interest in applying the idea in the United States, even as they noted important differences between the two countries.

Benefits: The discount window is a readily available instrument.

Risks: Cutting an already low rate might deliver only marginal benefits. It is unclear how offering banks cheaper funds -- particularly through a mechanism that carries stigma -- would translate to stronger demand in the economy. Additional discount window lending would also expand the Fed's balance sheet, which could be viewed as raising inflation risks.

(Reporting by Mark Felsenthal and Ann Saphir; Editing by Andrea Ricci)

Source: http://news.yahoo.com/factbox-tools-does-fed-spur-growth-182908439--business.html

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