The Fed's limited instruments: for FOMC policymakers, there is no obvious money play.

• Author: Berry, John M.

Federal Reserve Chairman Ben S. Bernanke doesn't want to admit it, but his central bank is running out of ways to boost U.S. economic growth to any marked degree.

The chairman and his colleagues on the Federal Open Market Committee long ago dropped their target for overnight interest rates to almost zero. To extend the potency of that move, the FOMC later signaled that absent an unexpectedly rapid economic recovery, it doesn't intend to raise that target until late 2014.

Along the way, the committee also directed the purchase of $2.3 trillion worth of longer-term Treasury and asset-backed securities in a successful effort to push down long rates. And long rates were reduced further through Operation Twist--a swap of Treasury securities maturing in the next three years for longer-dated ones--a process that will end late this year with virtually all of the Fed's holdings of the shorter-term paper gone.

What is left for the Fed? Not much. The central bank could buy more assets, but that probably would have only a limited effect on markets because long-term rates are already at record lows. For instance, in July's quarterly Treasury funding, bidders bought ten-year notes at a yield of a scant 1.46 percent, the lowest ever for an auction. A day later, thirty-year bonds were sold yielding just 2.58 percent. Such spectacularly low yields have helped in a variety of ways to ease strains in financial markets. However, that hasn't had nearly enough "oomph" to put the economy on a more solid growth path. And while having the Fed buy more Treasuries could lead investors to acquire other assets such as corporate bonds instead, yields on those securities are also already quite low.

Similarly, the conditional commitment to keep rates low for two more years could be extended to 2015 or 2016, but again, at the margin, how much would that help? Three-year Treasury notes were auctioned in July at a yield of just 37 basis points while five-year notes were at 60 basis points. In other words, zero is not far away even well out the yield curve.

All those efforts leave just one additional untried policy shift that a number of prominent economists have urged on the Fed: make it known one way or another that the central bank would seek, or at least tolerate, an inflation rate higher, and perhaps much higher, than its current 2 percent target.

Among those advocating such a shift are Paul Krugman of Princeton University, who is also a New York Tunes columnist; Christina D. Romer of the University of California at Berkeley, former chairman of President Obama's Council of Economic Advisers; her Berkeley colleague J. Bradford DeLong; Simon Wren-Lewis of Oxford University; and Joseph E. Gagnon, a former senior Fed economist now at the Peterson Institute for International Economics.

Despite the standing of such advocates, Bernanke and most other FOMC participants have flatly rejected the economists' approach. Asked about it at his press conference following the April FOMC meeting, Bernanke said, "I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of reduction in the unemployment rate? The view of the committee is that that would be very reckless."

The Federal Reserve, Bernanke said, has "spent thirty years building up credibility for low and stable inflation, which has proved extremely valuable in that we've been able to take strong accommodative actions in the last four or five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be tentative and perhaps doubt-fill gains on the real side would be, I think, an unwise thing to do."

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