“Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending,” said the Federal Reserve in their Open Market Committee statement Wednesday.

The biggest risk to “economic recovery,” said Ben Bernanke just a few days ago, is that we “don’t have the political will.”

Wednesday, the Federal Reserve demonstrated its own will — will to respond in drastic and essential ways by creating innovative solutions when the other solutions are used up. Plans were revealed to buy up to $300 billion U.S. in long-term government securities, mostly maturing in 2 to 10 years, over the next six months. It will also increase its share of mortgage-backed securities to $1.25 trillion — an increase of $750 billion — and purchase $100 billion more in debts from troubled mortgage agencies Fannie Mae and Freddie Mac.

The newly announced plans come after the bank reduced short-term interest rates to “between zero and 0.25%.” The bank says it expects these rates to remain low for a considerable period of time, as it attempts to stimulate the U.S. economy out of the recession it has been in since December of 2007. This interest rate adjustment is the conventional and accepted step to addressing business cycle concerns — but in this case, the interest rates did not have enough of an effect on the economy: the Federal Reserve began offering loans to financial institutions in trouble, making loan guarantees to AIG, Bear Stearns and other big names, and establishing a capital facility to purchase securities backed by the more risky loans such as mortgages and small-business loans.

The Federal Reserve’s balance sheet is expected to have increased by more than $3 trillion this year, accounting for all the new programs. In August of 2008, the Federal Reserve reported a balance sheet of just under $1 trillion, by October that number had reached over $1.5 trillion.

The Federal Reserve’s goals, quite concisely, are to lower the cost of private credit, and over the longer term, and as a side-effect of restoring faith and quality to credit markets, restoring the size of the monetary base (measured as currency and simple deposits) to prior levels.

The steps made over the last 6 months have successfully reduced the yield spread between the safest and riskiest assets, a factor which has been indicative of debt crisis in the United States. Liquidity issues at banks and financial institutions provided a shock to this spread which has yet to return to starting levels. By providing the zero to 0.25% rate, the Federal Reserve hoped to reduce rates on consumer loans — particularly adjustable rate mortgages, which could be significantly affected by a central rate cut — and ensure that credit markets can remain liquid, balancing off assets and liabilities with short-term loans.

When banks are unable to borrow from each other, like in the situation last fall, where creditors were unwilling to accept assets backed by mortgages or commercial paper, the system freezes. Overnight loans from the Federal Reserve’s “discount window” become the only source of maintaining day-to-day liquidity and the ability to make good on their debts; by lowering the rate at the discount window, and increasing the length of the loan terms made to banks, the Federal Reserve is ensuring banks can have their real Lender of Last Resort.

The recent steps to take up government debt in the form of purchasing Treasury securities to the tune of $300 billion is effectively akin to the government printing money. Rather than having the federal government monetize its spending through Treasury bills sold to the people and the world, the Federal Reserve simply “injects” the funds in to the economy to buy up the bills; a step which gets the monetary policy giant involved in fiscal policy and leaves many economists fearful of the inflationary side-effects.

Ben Bernanke downplayed the risk of inflation to the public, citing recent numbers of deflation as credit markets collapse, the monetary base shrinks and unemployment places downward economic forces on wages. The Federal Reserve’s Open Market Committee, the group responsible for overseeing such decisions approved these moves unanimously, effectively saying that such risks of inflation and the Federal Reserve’s involvement in government spending are acceptable.

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