The Federal Reserve will use more than $400 billion to try to drive down long-term interest rates, make home and business loans cheaper and invigorate the sluggish U.S. economy.
The action the Fed announced Wednesday is modest compared with previous steps, as the nation's central bank won't actually expand its $2.9 trillion holdings, instead just rolling them over.
Analysts said the moves would provide only a slight economic benefit, and the markets reacted skeptically. Stocks dropped immediately after the announcement at 2:15 p.m. and then continued falling, with the Dow Jones industrial average closing down about 283 points. The yield on the 10-year Treasury note tumbled, and its price rose.
The plan, dubbed "Operation Twist," resembles a program the Fed used in the early 1960s to "twist" long-term rates lower relative to short-term rates. It will sell $400 billion of its shorter-term Treasurys to buy longer-term Treasurys by June 2012. And it will reinvest principal payments from its mortgage-backed securities, to help keep mortgage rates at super-low levels.
Fed policymakers announced the moves after a two-day meeting, with three members of the 10 members dissenting from the decision. The Fed acted despite criticism from Republicans who have warned that such steps could ignite inflation.
"The actions the Fed has taken are helpful," says Josh Feinman, global chief economist at DB Advisors. "They will help hold down long-term rates, but they're no panacea."
The Fed left open the possibility of taking further action to try to strengthen the economy. In its statement, the Fed noted that the economy is growing slowly, unemployment is high and housing remains in a prolonged slump.
Under its plan, the Fed will extend the average maturity of its holdings from six years to eight years. The Fed has directed the New York Fed to buy Treasurys with remaining maturities of six to 30 years, and to sell an equal amount of securities with maturities of three years or less.
Analysts say the shift in the Fed's portfolio could reduce borrowing costs and perhaps raise stock prices.
"This is a measured response to weak economic conditions," said David Jones, head of DMJ Advisors and the author of four books on the Fed. "The Fed is still trying but it can only do so much."
Once the Fed announced last month that it would expand its September policy meeting from one to two days, economists anticipated some new action. Chairman Ben S. Bernanke had said the Fed was considering a range of options.
The Fed's move Wednesday came despite a rift within the central bank. The three members who dissented also did so at the Fed's August meeting — the most negative votes in nearly two decades.
The three dissenters — Richard Fisher, Narayana Kocherlakota and Charles Plosser, all regional Fed bank presidents — have said the Fed's policies may be raising the risk of high inflation. Still, the central bank is under pressure to revive an economy that has limped along for more than two years since the recession officially ended.
In the first six months of this year, the economy grew at an annual rate of just 0.7 percent; the housing market remains depressed; the unemployment rate is 9.1 percent with no net jobs being added in August; and consumers didn't increase their spending on retail goods.
Most economists foresee growth of less than 2 percent for the entire year. They say the odds of another recession are about one in three.