With Wall Street in Free Fall, Should the Fed Step In?

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Following the Dow's 600-point free fall today and Friday's S&P downgrade, the Federal Reserve may take measures to strengthen investor confidence, reports Bloomberg. Fed chief Ben Bernanke may prolong a monetary stimulus by "making a commitment to hold the Fed's $2.87 trillion balance sheet steady for an 'extended period,'" reports the news service. "The Fed also may replace shorter-term securities with longer maturities to reduce rates on longer-term debt." Beyond that, the Fed could simply hold its key interest rate near zero and specify the date it will hold the rate until. According to The Wall Street Journal, investors are now turning their attention to tomorrow's U.S. Federal Open Market Committee meeting where the fed will prescribe remedies for the U.S. economy. “It won’t be a boring meeting,” Lawrence Creatura, co-portfolio manager for Federated Clover Investment Advisers, tells Market Watch.  Is intervention the road the central bank should take?

It could help  "Those steps are all about bolstering confidence," said Michael Feroli, chief U.S. economist at JPMorgan Chase to Bloomberg. "It wouldn't do tons to alter economic and financial conditions, but the perception that the Fed will act and do something is reassuring."

There's an inflation risk  "The Fed could lower the interest rate it pays banks on excess reserves, forcing banks to lend the money to obtain higher rates of return," reports Reuters. "[But] after the Fed's $600 billion second round of quantitative easing, or QE2 as it became known, commodity and energy prices soared worldwide. The Fed was blamed for fueling inflation although Chairman Ben Bernanke and other economists argued rising demand around the world was the principal cause of rising prices."

It's a guessing game  "The question for them is whether this is a soft patch or a sustained slump in activity,” Karen Dynan, co-director of the Brookings Institution’s economic studies program and a former senior adviser to the Federal Reserve Board,  said. “We don’t know and they don’t know.”

Pegging a date for extended interest rates could boost confidence  "One thing they might do is be a little more explicit in what they mean by extended period," Mike Moran, chief economist with Daiwa Capital Markets America, told Forbes. “For example, instead of just saying we intend to remain accommodative for an extended period, they might say we will remain accommodative until well into 2012, or something along those lines.”

Quantitative easing might not work  "Detractors point to the continued struggles of the economy -- which grew at less than a 1 percent annualized rate in the first half of the year -- as signs of quantitative easing's limitations," reports Reuters. "Supporters counter that without the bond buying, things would have been worse."

Quantitative easing would be politically dangerous  "We’ve already had QE1 and QE2, and here we are today,” Pat O'Hare, chief market analyst with Briefing.com. said, noting that that hasn't helped the economy much “Participants who are looking for an actual QE3 announcement could be disappointed because the Fed has stated on a number of occasions now that it’s a really high bar in terms of implementing a QE3 program.”

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