Hi,Just read in article which goes:Yesterday, Fed Chairman Alan Greenspan told the Council on Foreign Relations he had the ammunition, not used since World War II, to keep deflation in check by holding 20-year bond rates down. But he may wait until he gets his bird for the day.which means that he would flood the market with 20 yr bonds.so how would that beat the deflation.Can anybody explain that to me.Thanks

I'm about as far from being a rates expert as one can be, but I believe he said that they would buy back the long notes - esp. ones of larger coupon. This is why he is now focusing on the gov't spending piece of the equation.

I understand he would buy the bonds with newly printed money. Injecting the new money into the economy is supposed to prevent deflation. At least that is the theory.

QuoteOriginally posted by: sandeepdJust read in article which goes:Yesterday, Fed Chairman Alan Greenspan told the Council on Foreign Relations he had the ammunition, not used since World War II, to keep deflation in check by holding 20-year bond rates down. But he may wait until he gets his bird for the day.which means that he would flood the market with 20 yr bonds. so how would that beat the deflation. Can anybody explain that to me.The comment is cryptic, you are right to ask for more information.First of all, to keep 20-year rates down you wouldn't flood the market with them (that would push prices down, hence yields up). You would buy up 20-year bonds. Although that would inject money into the economy, as Trendfollower suggested, that is not the main purpose. Money could be injected by buying any asset, including the traditional short-term treasury bills, or cutting taxes or increasing government spending or other ways.Monetary Policy When the Nominal Short Term Interest Rate is Zero laid out some radical options for battling deflation and stimulating demands after rate cuts have moved the Fed Funds rate to zero. Greenspan was alluding to one of these strategies, buying long-term government bonds. At the same meeting Fed governor Ben Bernanke discussed the other, even more radical, options. This paper has been very influential in the Fed, all the authors are Fed advisors.The case for buying long-term bonds to prevent deflation is weak. Research indicates that small amounts of deflation (on the order of 1% per year) cause long-term rates to fall (that makes sense, you'll take a lower interest rate if you expect money to buy more in the future) but stronger deflation leads to increases in long term rates (presumably because investors lose faith in the currency, figuring that prolonged, intractable deflation will be followed by hyperinflation). So keeping long-term rates down makes some counterintuitive sense if you want to prevent deflation. But there's no evidence that (a) the Fed or anyone else has the power to keep long-term rates down or (b) keeping long-term rates down would prevent or cure deflation or even (c) the Fed has the authority to act this way. Moreover there are troubling possible side-effects.What's really going on here is Greenspan and Beranke are making two signals to the market. The first is "we're tough and serious, here's all the crazy experiments we'll try before letting commodity prices deflate further." The second is "buy and hold long-term bonds at low interest rates, we'll protect you against both inflation and deflation." Only the most naive observers will automatically assume that the signals show the true direction of Fed planning, it might or might not. The signals certainly overstate the Fed's willingness to actually do this, Greenspan is hoping the signal alone will do the trick.

thanks Aaron that makes sense.I felt that this was more of read between the lines kind of message by the fed.