Fed Mulls Policy Change in Light of Sagging Recovery

Today, The Wall Street Journal reports that the Federal Reserve is looking at a symbolic policy change in light of the sagging recovery — something designed to restore confidence, rather than to attack primary problems like stagnant wages or high rates of joblessness.

The issue: Whether to use cash the Fed receives when its mortgage-bond holdings mature to buy new mortgage or Treasury bonds, instead of allowing its portfolio to shrink gradually, as it is expected to do in the months ahead. Any change — only four months after the Fed ended its massive bond-buying program — would signal deepening concern about the economic outlook. If the Fed’s forecast deteriorates significantly, it could also be a precursor to bigger efforts to pump money into the economy.

Moving to stop the Fed’s portfolio from shrinking would prevent monetary policy from slightly tightening in the face of a weakening recovery.

Buying new bonds with this stream of cash from maturing bonds — projected at about $200 billion by 2011 — would show the public and markets that the Fed is seeking ways to support economic growth. It could also be a compromise that rival factions at the Fed support, as officials differ about whether and how to address a subpar recovery.

The central bank’s $2.3 trillion portfolio has nearly tripled in size since 2007.

This is not much, but it is something. The Journal reports that the Fed will make its decision after seeing the rest of this week’s economic data. This morning, the Bureau of Economic Analysis reported that spending declined last month, signaling a strong fade in the recovery. All in all, the Fed has shown real conservatism in ringing alarm bells about the economy. Yesterday, for instance, Bernanke addressed the budgeting crisis facing states, which are not allowed to run deficits. He did not say the federal government should supply funds to help avoid layoffs and cutbacks to programs like Medicaid. Instead, he said states should keep bigger rainy day funds in the future.