With unemployment likely to hit double digits this year, the Federal Reserve must strike a reassuring message this week: That it stands ready to take further steps to nurse the economy back to health, but also make clear that too much medicine could spur worries about inflation later on.
Some economists say that at the end of their two-day meeting Wednesday, Fed Chairman Ben Bernanke and his colleagues may say they will stretch out their purchases of government debt to avoid an abrupt end to that effort, now slated for August. Doing so could help avert possible market disruptions and help ease fears about a stimulative overdose that could trigger inflation.
"I think there's a good chance the Fed will exert more flexibility in the timing of purchases to slow them down," said Michael Feroli, an economist at JPMorgan Economics.
In March, the Fed launched a bold $1.2 trillion effort to drive down rates on mortgages and other consumer debt, to try to revive lending and get Americans to spend more freely again. It said it would spend up to $300 billion to buy long-term government bonds over the next six months and boost its purchases of mortgage securities. So far, the Fed has bought about $177.5 billion in Treasury bonds.
Some analysts said the Fed also might opt to slow its purchases of mortgage-backed securities. The Fed is on track to buy up to $1.25 trillion worth of securities issued by Fannie Mae and Freddie Mac by the end of this year or early next year. Its recent purchases have averaged $455.3 billion.
Feroli and other analysts also said it's possible the Fed might change the mix of the government and mortgage-backed securities it's buying to limit any unintended effects on prices and trading.
"The Fed's action on the mortgage side is having an adverse impact on liquidity," Feroli said. "Not a lot is being traded because the Fed is buying up anything that hits the market and is holding on to it. You can get whippy price moves."
What's all but certain is that Fed policymakers will hold a key lending rate to banks at a record low near zero. They also are likely to repeat a pledge to keep rates there for "an extended period."
Most economists say that means the Fed will keep the target range for its bank lending rate between zero and 0.25 percent through the rest of this year and probably into next year to help brace the economy. That means commercial banks' prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will stay around 3.25 percent, the lowest rate in decades.
Bernanke has predicted the recession will end later this year. Some economists say the economy will start growing again as soon as the July-to-September quarter as the Fed's actions so far, along with the federal stimulus of tax cuts and increased government spending, take hold.
But some on Wall Street worry that a recent run-up in rates on mortgages and Treasury securities, if prolonged, could choke off prospects for an economic recovery. Some of those fears were eased last week, when rates on 30-year mortgages dipped to 5.38 percent after a string of weekly increases.
Most economists say the Fed won't be inclined to boost its purchases of government debt or mortgage-backed securities at this week's meeting, preferring to take time to assess the impact of its actions already taken.
There will be "no fireworks from the Fed," predicted Michael Darda, chief economist at MKM Partners.
With unemployment expected to worsen and with factory production sagging, Darda and other economists said inflation is unlikely to sprout any time soon.
"Don't expect the Fed to start laying the groundwork for tighter monetary policy" until there is sustained turnaround in factory and employment activity, Darda said.
And that will take awhile, because an eventual recovery is likely to be tepid. Still, Fed policymakers will continue to explore how and when to wean the economy off stimulative medicine to avoid fanning inflation.