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When Fed rate hits zero, what’s next?

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Kai Ryssdal:
So here’s a nifty macro-economic problem with some real-world applications.
What do you do if you’re running an economy and you run out of room?
Room on interest rates, in this case.
One of the textbook solutions to get things going again is to cut those rates.
But Ben Bernanke’s already done that already–and he’s done it a lot.
The federal funds rate is 1 percent right now.
And since you can’t really drop it lower than zero, the chairman of the Fed’s probably going to have to get creative.
Marketplace’s Nancy Marshall Genzer looks at how he might do that.

Nancy Marshall Genzer:
Fed Chairman Ben Bernanke says the Fed could jump-start the economy by buying U.S. Treasury securities. As demand went up, Treasurys could pay less interest. Mortgages and other loans are tied to Treasury interest rates. So, Wachovia senior economist Mark Vitner says mortgage rates would fall and stimulate re-financing.

Mark Vitner: And that would free up some cash to either rebuild savings and strengthen household balance sheets, or to drive consumer spending.

Some economists say, if the Fed starts buying Treasuries, it’ll be following in Japan’s footsteps. Basically, using Treasuries to control long term interest rates, and encourage lending. But University of Chicago Finance professor Douglas Diamond says it didn’t work so well for Japan in the 1990s.

Douglas Diamond: Some people think the one reason it didn’t work in Japan is because their banking system was in such poor shape. Just giving banks incentives to lend when they’re all broke didn’t really work.

Diamond says U.S. banks are in better shape. But there’s another problem. The U.S. will bump up against bigger players who bought Treasurys and are holding them. Who are they? Give you one guess–yep, China. And Japan. Catherine Mann is a professor at Brandeis International Business School. She says the effect of buying Treasuries might just be psychological.

Catherine Mann: They’re using yet another arrow in the quiver to try and slay the financial crisis dragon.

The downside?

Mann: You run the risk that it doesn’t work and psychology is damaged further.

But right now, that’s a risk dragon fighter Bernanke is willing to take.

In Washington, I’m Nancy Marshall Genzer for Marketplace.

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