September 14, 2010

Bolstering Fed Policy Stimulus with Enhanced Communications

• It would be premature for the Fed to initiate a new program of asset purchases next week; recent economic
indicators speak more to a sluggish growth pace (in the context of diminished growth potential) than to a loss
of momentum en route to a double-dip recession, and high–frequency business credit data suggest that the
prevailing policy stance may be starting to gain traction.

• At the same time, the Fed could add to the stimulative thrust of its current policy stance by expanding its
forward guidance to include its balance sheet as well as the fed funds rate. Clarifying expectations of the
future path of the Fed’s portfolio might encourage banks to deploy excess reserves more aggressively.

• The main risk in further asset purchases pertains to the rates that the Fed might have to pay to elicit demand
for reverse repurchase agreements and term deposits sufficient to facilitate fed funds trading at a non-zero
target rate in the presence of an even larger balance sheet.

The Federal Reserve’s latest “Beige Book” survey of “tools and strategies for providing additional
economic conditions indicated “continued growth in stimulus.” 2
national economic activity during the reporting period
of mid-July through the end of August, but with Additional Fed asset purchases not yet in order
widespread signs of a deceleration compared with
In our view, however, it would be premature to initiate
preceding periods.”1 Against this backdrop, next
a new program of asset purchases next week; the
week’s meeting of the Federal Open Market
economy shows more signs of shifting to a somewhat
Committee will likely include further discussion of the
2
Ben S. Bernanke, “The Economic Outlook and Monetary Policy,”
At the Federal Reserve Bank of Kansas City Economic Symposium,
1
“The Beige Book,” Federal Reserve Board, September 8, 2010. Jackson Hole, Wyoming, August 27, 2010.

Trend Toward Easier Lending Standards Signals Upturn in C&I Borrowing

Figure 1
-30 30
Net Pct. Tightening (inverted)

20
Percent Change, Year Ago

0
10

30 0

-10
60
Lending Standards, 6 quarters ahead, inv erted (L) -20
C&I Loans (R)
90 -30
93 95 97 99 01 03 05 07 09 11
Source: Federal Reserv e, Hav er Analy tics, T. Row e Price

Alan D. Levenson, Chief Economist

410-345-2067/alan_levenson@troweprice.com
slower growth pace than of losing momentum en example, based on an earlier majority view in favor of
route to a double-dip recession. Nor are we convinced deferring asset sales until after rate hikes have
that further asset purchases will be forthcoming over commenced,4 the Committee could expand its policy
a longer time horizon, in part owing to evidence that guidance as follows to incorporate both the interest rate
the prevailing policy stance may be starting to gain and balance sheet instruments currently in use:
traction. For example, the turn toward banks easing
“The Committee will maintain the target range for
standards for commercial and industrial loans signals
the federal funds rate at 0 to ¼ percent and continues
a cyclical recovery in this lending segment (Figure 1,
to anticipate that economic conditions…are likely to
page 1). Indeed, while the year-to-year growth rate is
warrant exceptionally low levels of the federal funds
still negative, recent data indicate an emerging trough
rate and an enlarged, diversified [not Treasury-only]
in the stock of loans outstanding (Figure 2).
securities portfolio for an extended period.”5
(Sample expanded policy guidance in italics.)
Two-channeled policy guidance would enhance the
degree of accommodation in the current stance
The risk in additional asset purchases: paying up to
Fed Chairman Bernanke believes that, “the degree of manage an even larger balance sheet
accommodation delivered by the Federal Reserve's
Bernanke and others have conceded that the impact of
securities purchase program is determined primarily
securities purchases in the current environment is likely
by the quantity and mix of securities the central bank
to fall short of that observed when markets were less
holds or is anticipated to hold at a point in time3
liquid and term premiums were unusually high. Thus,
(italics added). If the FOMC shares this view, then it
“the expected benefits of additional stimulus from
could increase the degree of accommodation
further expanding the Fed's balance sheet would have to
delivered by the Fed’s current portfolio size and mix
be weighed against potential risks and costs.”6
by clarifying market participants’ expectations of its
future path.
In our view, the most prominent risk is associated with
the increase in the size of the balance sheet that the Fed
Depository institutions might be encouraged to
would carry into the inevitable – if distant – rate
deploy excess reserve balances more aggressively if
tightening cycle. The Fed currently carries over $1
they were assured that they were not going to find
trillion of excess reserves on its balance sheet, virtually
themselves suddenly short of liquidity if, say, the Fed
all of which would have to be prevented from entering
reverted to a policy of allowing its securities portfolio
the fed funds market in order for the Fed to facilitate
to shrink with the return of principal from GSE-
trading near a non-zero target rate. While the authority
related securities. For (an admittedly simplistic)
to pay interest on excess reserves is an important tool
toward this end, the Fed developed supporting capacity
3
ibid.
– the ability to issue reverse repurchase (RP)
agreements and term deposits – to capture liquid assets
A Turn in the Business Borrowing Trend? held by nonbank intermediaries that are not eligible to
Figure 2 hold reserve deposits at the Fed. For example, GSEs and
1400
money market mutual funds held $176 billion and $440
billion, respectively, in fed funds and securities RP at
the end of the first quarter.

1350 Presumably, the Fed will have to offer a rate slightly

above the target funds rate in order to stimulate demand
for potentially hundreds of billions of dollars of these
instruments. The risk in another round of Fed asset
$ Billions

1300 purchases is that the associated increase in excess

reserve deposits spills over onto the balance sheets of
nonbank intermediaries, requiring offsetting sales of
reverse RP and term deposits, and potentially higher
1250 rates – in absolute terms and relative to the fed funds
target – to elicit the required demand.

1200 4
Minutes of the Federal Open Market Committee, April 27-28, 2010.
Oct-09 Jan-10 A pr-10 Jul-10 5
FOMC Policy Statement, August 10, 2010.
6
Ben S. Bernanke, “The Economic Outlook and Monetary Policy,” At
Commercial & Indust rial Loans the Federal Reserve Bank of Kansas City Economic Symposium,
Jackson Hole, Wyoming, August 27, 2010.
Source: Federal Reserve, Haver Analytics, T. Rowe Price

September 14, 2010 T. Rowe Price U.S. Economic Perspective 2

Offices and Investor Centers of the T. Rowe Price Group of Companies
UNITED STATES OFFICES INTERNATIONAL OFFICES (Cont’d.) INVESTOR CENTERS (Cont’d.)
Baltimore Singapore Los Angeles
100 East Pratt Street No. 290 Orchard Rd. 10100 Santa Monica Blvd., Suite 100
Baltimore, Maryland 21202 #14-04 Paragon Los Angeles, California 90067
410-345-2000 Singapore 238859 310-772-3000
011-65-836-0098
Financial Center San Francisco
10090 Red Run Boulevard Argentina 1990 N. California Blvd., Ste. 100
Owings Mills, Maryland 21117 Carlos Pellegrini 1149, piso 12 Walnut Creek, California 94596
410-345-2000 (1009) Buenos Aires 925-817-1900
Argentina
Corporate Campus 011-54-11-4394-4089 Tampa
4515 Painters Mill Road 4211 West Boy Scout Blvd., 8th Floor
Owings Mills, Maryland 21117 Australia Tampa, Florida 33607
410-345-2000 Levels 25 & 29 Chifley Tower 813-554-4000
2 Chifley Square
Technology Center Sydney NSW 2000 Washington, DC
11550 Cronridge Drive Australia 900 17th Street, NW
Owings Mills, Maryland 21117 011-61-2-9293-2894 Farragut Square
410-345-2000 Washington, DC 20006
Denmark 202-466-5000
Colorado Springs Lautrupsgade 7
2260 Briargate Parkway 2100 Copenhagen New Jersey
Colorado Springs, Colorado 80920 Denmark 51 JFK Parkway, 1st Floor W
719-278-5800 011-45-33-36-05-00 Short Hills, New Jersey 07078
973-467-6800
San Francisco Luxembourg
333 Bush Street, Suite 2550 Boulevard Royal 26 Paramus
San Francisco, California 94104 2449 Luxembourg 81 E. Route 4 West, Suite 102
415-772-9950 Grand Duche de Luxembourg Paramus, New Jersey 07652
Tampa 201-712-4700
Switzerland
4211 West Boy Scout Blvd
Dreikoenigstrasse 31a New York
Tampa, Florida 33607
8002 Zurich 1100 Franklin Ave., Suite 101
813-554-4000
Switzerland Garden City, New York 11530
Long Beach 41 44 208 3905 516-535-6100
4401 Atlantic Avenue, Ste. 200
Long Beach, CA 90807 Canada Illinois
Brookfield Place – TD Canada Trust Tower 1900 Spring Road, Suite 104
562-422-8812
161 Bay Street, Suite 2700 Oak Brook, Illinois 60523
INTERNATIONAL OFFICES Toronto, ON M5J 2S1 630-645-9700
Canada
Netherlands 1 416 572 2580 Illinois
Strawinskylaan 1047 40 Skokie Blvd., Suite 100
1077 XX Amsterdam INVESTOR CENTERS Northbrook, Illinois 60062
The Netherlands Baltimore 847-313-4500
31.(0)20.333.62 00 105 East Lombard Street
Baltimore, Maryland 21202 Tysons Corner
England 410-345-5757 1600 Tysons Blvd., Suite 150
60 Queen Victoria Street McLean, Virginia 22102
London EC4N4TZ Owings Mills 703-873-1200
England 4515 Painters Mill Road
011-44-20-7651-8200 Owings Mills, Maryland 21117 Boca Raton
410-345-5665 Wachovia Plaza
Japan 925 S. Federal Hwy., Suite 175
NBF Hibiya Building – 20th Floor Massachusetts Boca Raton, Florida 33432
1-7, Uchisaiwai-cho 1-chome 386 Washington Street 561-338-4300
Chiyoda-ku, Tokyo 100-0011 Wellesley, Massachusetts 02481
Japan 781-263-1200
011-81-3-3504-1810
Colorado Springs
Hong Kong 2260 Briargate Parkway
Jardine House
Colorado Springs, Colorado 80920
21st Floor
719-278-5700
1 Connaught Place
Central
Hong Kong
011-852-2536-7800

September 14, 2010 T. Rowe Price U.S. Economic Perspective 3

T. Rowe Price Economics Department, T. Rowe Price Associates, Inc.
Chief Economist Associate Economist Research Liaison
Alan Levenson Jared Franz Linda Smith
(410) 345-2067 (410) 345-7657 (410) 345-5782
Alan_Levenson@troweprice.com Jared_Franz@troweprice.com Linda_Smith@troweprice.com

100 East Pratt St., Baltimore, MD 21202

1-800-225-5132/www.troweprice.com

Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange
Commission. The material is not intended to be a solicitation for any product or service not available to U.S. investors, and may be distributed only to institutional
investors.

Issued in Japan for purposes of its investment management business by T. Rowe Price Global Toshi Komon (“TRPGTK”), located at Yamato Seimei Building 20F, 1-
7, 1 chome Uchisaiwai-cho, Chiyoda-ku, Tokyo 100-011. If instead this material is used in Japan on behalf of an affiliated T. Rowe Price Group Company, TRPGTK
has translated and provided it consistent with the scope of its side business license. This material is intended for use by professional investors only.

Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment
management services. T. Rowe Price (Canada), Inc. is not registered to provide investment management business in all Canadian provinces. Our investment
management services are only available to select clients in those provinces where we are able to provide such services. This material is not intended for use by Private
Customers. T. Rowe Price, Invest With Confidence and the Bighorn Sheep is a registered trademark of T. Rowe Price Group, Inc. in the United States.

Issued in Australia by T. Rowe Price Global Investment Services Limited (“TRPGIS”) Level 25, Chifley Tower, 2 Chifley Square, Sydney NSW 2000 Australia.
TRPGIS is exempt from the requirement to hold an Australia Financial Services License (“AFSL”) in respect of the financial services it provides in Australia.
TRPGIS is regulated by the FSA under UK laws, which differ from Australia laws. This material is not intended for use by Private Customers, as defined by the UK
FSA.

Issued outside of the USA, Japan, Canada, and Australia by T. Rowe Price Global Investment Services Limited, 60 Queen Victoria Street, London EC4N 4TZ, which
is regulated by the UK FSA. The material is not intended for use by Private Customers, as defined by the UK FSA. T. Rowe Price, Invest With Confidence and the
Bighorn Sheep is a registered trademark of T. Rowe Price Group, Inc. in the United Kingdom. This material was developed and produced in the United Kingdom.

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are as of September 14, 2010, and may have changed since that time.

Copyright © 2010 by T. Rowe Price Associates, Inc.

All rights reserved.

September 14, 2010 T. Rowe Price U.S. Economic Perspective 4