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Has the Fed Painted Itself Into a Corner?

August 16, 2010

| MoneyRates.com Senior Financial Analyst, CFA

Last week's Federal Reserve meeting ended with less than the usual fanfare in the financial press. It would appear editors are beginning to realize that "Fed Does Nothing -- Again" doesn't make for much of a headline.

With the Fed funds rate near zero for a year and a half now, the Fed has few places to go with monetary policy. The best it could muster last week was a decision to roll some proceeds from earlier purchases of mortgage-backed securities into the purchase of U.S. Treasury bonds.

The move to buy bonds is a technique to keep long-term interest rates low. The Fed can directly control very short-term interest rates (e.g., rates used for overnight lending to banks for liquidity purposes) but as a practical matter, longer-term rates that affect consumer loans are a function of bond market trading. When the Fed buys bonds on that market, it pushes the price of bonds up, and the yield, or effective interest rate, on those bonds down.

This is all well and good, but since the Fed is simply rolling over proceeds that were already in the bond market in one form or another, the Fed is simply keeping its foot on the accelerator, rather than providing some new boost to the economy. Plus, the stimulus of keeping interest rates low hasn't had much impact on an economy in which there seems minimal desire for borrowing or lending. Unfortunately, the Fed has little additional room to maneuver.

With interest rates likely to stay low, consumers need to take it on themselves to shop around for the best CD rates, money market rates, and offers on savings accounts. You can find rates that are several times the national averages, so why wait for a change in Fed policy?

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