Fed Has More Ammunition After Firing Rate-Cut Bullets.

While there are limits to how low short-term interest rates can go, the Fed has shown recently that there are few constraints on how large its own balance sheet can become. Since late August, the value of assets held by the Fed has grown to more than $2 trillion from a little less than $900 billion. The Fed has essentially created cash and used it to fund a multitude of new lending facilities, including a program to buy private commercial paper, one to rescue loans for American International Group and one that pumps dollars into financial institutions overseas through other central banks. This activity is sometimes called quantitative easing. Rather than focus on the cost of money in the financial system -- which is the interest rate -- policy makers focus on the quantity of money in the system. Now, the Fed and Treasury are considering a program in which they would team Fed loans with funds from the Treasury's $700 billion financial-rescue program to acquire securities from troubled financial institutions. In addition to targeting already-low short-term interest rates, the Fed could try to lower long-term ones, which could bring down costs on everything from 30-year mortgages to car loans to medium-term corporate bonds. "It is longer maturity rates that matter for economic activity," said Vincent Reinhart, another former Fed staffer who co-authored work on the subject with Mr. Bernanke. The Fed could achieve this by purchasing long-maturity debt, including Treasury bonds or debt issued by Fannie Mae and Freddie Mac. The Fed could seek to influence longer-term interest rates by committing to keep short-term rates low for a long time. That could force investors to price in lower rates for longer-term securities, too. The Fed took such a step in 2003 when it committed to keep the federal-funds rate low for a "considerable period."