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6 Tools Left in Bernanke's Toolbox as QE2 Ends

NEW YORK ( TheStreet) -- No one expects Federal Reserve Chairman Ben Bernanke to pull a rabbit out of his hat after quantitative easing ends today, but he may still have a few tricks up his sleeve if the economic picture fails to improve.

For now, the Fed is set to sit tight. Along with investors, Bernanke is looking for a silver lining in economic data. If this summer's numbers turn bleaker, then Bernanke's team will be forced to go back to the drawing board, that is, if it hasn't already done so. Bears will of course say, "I told you so."

Traditionally, the central bank has three tools for monetary policy -- buying and selling treasuries in the open market, setting the discount rate and dictating reserve requirements -- all of them blunt at best.

We stretched our imaginations to find the leftovers in Bernanke's toolbox. Not surprisingly, the following list comes with big caveats from analysts. And don't forget, Bernanke has his own warning too: "All of these things are somewhat untested."

1. Cut the interest rate on excess reserves

The current rate that the central bank pays banks holding more deposits than required is 0.25%, about the rate at which banks lend to each other. If the Fed lowers the rate on excess reserves, the mechanics say that banks should loan out more, both to each other and to the public.

Can this work?

  • "It should," says Steve Blitz, economist at ITG Investment Research.
  • "Looks promising," says Peter Cardillo, chief market economist at Avalon Partners.
  • However, just because banks might be more willing to supply money, lenders won't necessarily jump at the opportunity to borrow. The Fed can essentially toy with the "supply side," explains Blitz, but if a corporate America doesn't want the extra cash (and corporations do have a lot of cash sitting on their balance sheets already), then forcing more liquidity is pretty useless.

    2. Buy more securities and structure them differently

    Otherwise known as a third round of quantitative easing in disguise. The Fed has already said it will keep buying up long-term Treasuries in the months to come. Total purchases will likely add up to at least $300 billion. Investing in corporate bonds is still an option on the table. Albeit we were in quite different times during the housing bubble when the central bank dumped $1.25 trillion in mortgage-backed securities, we've learned that the Fed is ready to move on new methods when necessary.

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