The Fed's 'pact with the devil' now the only stimulus game in town

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WASHINGTON — Any more stimulus spending by President Barack Obama and Congress is dead, after this week’s election blowout by the Republicans. Yet, Federal Reserve Chairman Ben Bernanke’s “Hail Mary” pass to pump $600 billion into the banking system is really stimulus spending under another name.

The Fed won’t be spending taxpayer money or borrowing from China. It will be doing the electronic equivalent of creating dollars out of thin air. The central bank will then use the new money to buy longer-term government bonds. The Fed’s plan will initially increase the supply of dollars held by banks, hopefully spurring more lending.

If all goes according to Bernanke’s script, the bond purchases – $75 billion a month for eight months – should force down yields, taking with them interest rates for homeowners, consumers and businesses. It should also help make U.S. goods more competitive overseas and keep alive a stock market rally that began in August.

All of that should boost economic growth, help the ailing housing market and encourage more hiring.

It may not work. And there are risks.

Printing so much new money could lead to runaway inflation down the road. Lower interest rates could also produce speculative bubbles in the price of oil and other commodities and in risky high-yield investments. It could also take pressure off the White House and Congress to confront the long-term deficit crisis.

Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, calls it “a pact with the devil.” He was the only dissenter in the Fed policy committee’s 10-1 vote for the Fed effort, also known as quantitative easing.

The bold move – carefully choreographed since last summer – came as the central bank was starting to run out of arrows in its quiver. Its main weapon for revving up or slowing down the economy is adjusting short-term interest rates. But, given the magnitude of the downturn, the Fed has held those rates at near zero since December 2008.

Fed leaders figure the $600 billion bond-buying program will provide a modest boost to the economy over the next year, but they acknowledge that the jobless rate, now at 9.6 percent with nearly 15 million unemployed, will stay high. And it could even rise in the next few months.

It is the Fed’s second experiment with buying bonds on the open market. From December 2008 to this past March, it bought $1.7 million in Treasurys and mortgage-backed securities. But since then, the recovery has faltered.

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