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As Rate Nears Zero, What Else Can Fed Do?

Faced with persistent economic weakness, the Federal Reserve is expected Tuesday to cut short-term interest rates once again. Analysts expect the Fed to lower its key rate by at least a half-percentage point to 0.5 percent. An announcement is due at 2:15 p.m. ET.

The federal funds rate was at 4.75 percent when the Fed started cutting rates in September 2007. As the rate moves closer to zero, the Fed must find alternatives to its traditional tool of cutting rates to help the economy, says David Wessel, economics editor of The Wall Street Journal.

As bad as the economy has gotten, it might have been worse had the Fed not cut interest rates, Wessel tells Renee Montagne.

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But at a time when banks are reluctant to lend and people are reluctant to — or can't — borrow money, Wessel says, "just cutting interest rates doesn't do its usual magic of getting the economy going."

As it approaches a zero percent short-term rate, the Fed is considering what else it can do to spur economic growth.

"One way would be to try to lower long-term interest rates — the 10-year and 30-year rates in the Treasury bond market," Wessel says. The Fed may also try to encourage borrowing by putting out the message that rates are low and will be for a long time.

"But neither of those seem to be immediate options" for policymakers, Wessel says.

The central bank is eyeing the gap between the Treasury's borrowing rates and the rates consumers pay for loans.

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"They're looking at kind of surgical strikes," Wessel says of the Fed. "Instead of working through the banking system, they're going to try and effectively lend directly to various markets."

The Fed has already targeted the mortgage market for hundreds of billions of dollars, and it's looking for ways to make money available for auto loans, student loans and business loans, Wessel adds.

The Fed hopes that the massive fiscal stimulus proposed by the incoming Obama administration will also help the economy, Wessel says. Fed policymakers are wary that over-stimulating the economy through lower rates and government spending will trigger higher inflation down the road, but it's a risk they're willing to take for now.

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