Announcing the consultation, Justice Minister Bridget Prentice said: "Excessive costs and their threat may force defendants to settle unwarranted claims.
"The aim of these proposals is to bring more effective cost control to litigation in defamation proceedings and to ensure that costs in this area are more proportionate and reasonable.
"We need to ensure that people's right to freedom of expression is not infringed, and media organisations continue to report on matters of public concern."
Libel costs for news organisations have escalated in recent years because of the huge costs of settling cases brought under no win, no fee rules.
These Conditional Fee Agreements allow claimants to pay nothing up front on the understanding that their lawyers can double their money if they win.
With media lawyers charging up to £700 an hour, costs settlements often hugely outweigh any damages paid.
Earlier this month, Guardian editor Alan Rusbridger revealed that Carter Ruck had issued his newspaper with a bill of £803,000 for a libel action which had resulted in a payout to Tesco which is believed to have been just a few thousand pounds.
And he has warned that such costs seriously undermine the ability of journalists to carry out investigative journalism.
Last year, the Mail on Sunday paid £5,000 in damages to MP Martyn Jones after accusing him of swearing at a Commons official - but paid out £520,000 in libel fees.
And in in 2005, the Daily Mirror was handed a £594,000 costs bill by law firm Schillings for representing model Naomi Campbell at a two-day House of Lords privacy hearing.
Measures being considered under the consultation, which closes on 6 May, include:
- Limiting recoverable hourly rates by setting either maximum or fixed recoverable rates.
- Mandatory cost capping or mandatory consideration of cost capping in every case.
- Requiring the proportionality of total costs to be considered on cost assessments conducted by the court.
The Ministry of Justice statement said: "The consultation is necessary in addition to the current arrangements to help achieve better costs control in this area of the law.
"The consultation is aimed at, in particular, legal representatives who conduct litigation in the area of defamation, media organisations, insurers and those in England and Wales with an interest in, or views on, the proposals."
Last week, a newly published academic study revealed that libel costs in England and Wales were 140 times the average of 11 other European countries.
Speaking at the Press Gazette Media Law Conference earlier this month, Justice Secretary Jack Straw said that he made been made aware of the problems caused by the CFA system after a case brought against his local paper in his Blackburn constituency, the Lancashire Evening Post.
"They raised a case with me where the damages awarded were relatively manageable - around £1,000, though it was quite difficult to see where the merit was in the case, but the costs ran into about £25,000 for the other side.
"I don't regard this as acceptable - I have established a review."
He added: "There's an issue here of proportionality and of looking very carefully at the way in which the CFA system has operated and whether it's leading to unjust conclusions when newspapers are being forced to settle."
Speaking at the same conference, lawyer Julian Pike revealed that the cost risk to a publisher of defending a major libel case at trial was now £2.4m.
According to the Ministry of Justce around 220 defamation cases are issued in the High Court at the Royal Courts of Justice each year.
It estimates that a further 300 claims are settled before court proceedings are issued.
Press Gazette has been highlighting media concerns about CFAs since last year under its Fair Play on CFA campaign.
Editor's comment: CFAs are now a matter of economic life and death for publishers
Ministry of Justice consultation paper: Controlling costs in defamation proceedings
Source: Press Gazette