How the Fed's Treasury-buying program would work

AP News
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Posted: Oct 15, 2010 4:19 PM
How the Fed's Treasury-buying program would work

The Federal Reserve is all but certain to launch another program to buy government debt. Here's how it would work:

THE MECHANICS:

_ To buy Treasury debt, the Fed in effect prints money. It does so by expanding its balance sheet, which now stands at $2.3 trillion. The balance sheet has nearly tripled since the end of 2007. That's when the economy slid into recession and the Fed embarked on programs to loosen credit.

_ The Federal Reserve Bank of New York would actually buy the longer-term government debt. The amount and the frequency would hinge on the size and structure of the Fed's program. Those decisions have yet to be made.

Once the Fed settles on a plan, the New York Fed would buy the bonds electronically on the open market. In doing so, it would compete with other investors. During the recession, when the Fed cut its key interest rate to a record low near zero, the New York Fed bought short-term Treasurys. When the Fed wants to tighten credit, the New York Fed sells securities. The process is called "open market operations."

THE ECONOMIC MISSON:

_ As the Fed snaps up Treasury bonds, the rates on those bonds will fall. Rates on mortgages, corporate debt and other loans pegged to the Treasury securities will drop, too. It involves supply and demand: Higher demand for bonds lowers their rates, or yields. And it drives up their prices.

_ The Fed's goal is for those cheaper loans to entice Americans to spend more. Stronger sales could make businesses borrow and spend and hire more employees. Those forces could generate more business activity and strengthen the economy.