Fed chief: We have tools for an exit strategy

Business Times - 22 Jul 2009

US economic outlook improving but joblessness to stay high, says Bernanke

(WASHINGTON) US Federal Reserve chairman Ben Bernanke yesterday said that the outlook for the long-suffering US economy appears to be improving and that the US central bank was carefully reviewing ways to withdraw its massive monetary policy stimulus when conditions permit.

But Mr Bernanke cautioned that unemployment was likely to remain high into 2011, and he warned that this could sap fragile consumer confidence and potentially undermine what is expected to be a very gradual recovery.

'The (Fed) believes that a highly accommodative stance of monetary policy will be appropriate for an extended period,' he said in remarks prepared for delivery to the House of Representatives Financial Services Committee.

'However, we also believe that it is important to assure the public and the markets that the extraordinary policy measures we have taken in response to the financial crisis and the recession can be withdrawn in a smooth and timely manner as needed, thereby avoiding the risk that policy stimulus could lead to a future rise in inflation,' he said.

Said Boris Schlossberg, director for currency research at GFT Forex in New York: 'The Fed has zero intention of tightening monetary policy any time in the near future. They want to keep the conditions in place to sustain this fragile economic recovery.'

The Fed has cut interest rates to almost zero and doubled the size of its balance sheet to around US$2 trillion as it pumped money into the economy to fight a severe recession after a financial panic last year cracked global credit markets.

Some economists, including some policymakers, have worried that this dramatic expansion of Fed liquidity and lending may have sown the seeds for inflation to blossom as the recovery gains traction.

Mr Bernanke, delivering the Fed's semi-annual report to Congress on the economy, took pains to promise that the US central bank had an array of weapons at its disposal to withdraw its unprecedented monetary stimulus when the time was right, even if its balance sheet remains large for a time.

'The (Fed) has been devoting considerable attention to issues relating to its exit strategy, and we are confident that we have the necessary tools to implement that strategy when appropriate,' he said, echoing comments he made in an article published late on Monday on the Wall Street Journal's website.

'Should economic conditions warrant a tightening of monetary policy before this process of unwinding is complete, we have a number of tools that will enable us to raise market interest rates as needed,' Mr Bernanke said.

Paying interest on the reserves that banks hold at the Fed - a tool used by other central banks - is chief among these devices, Mr Bernanke said. By raising the amount of interest it is willing to pay, the Fed can encourage banks to park excess cash at the central bank.

The Fed's monetary policy report also detailed a number of other measures that policymakers could employ, steps that Mr Bernanke had also outlined in his newspaper piece.

The report said the Fed could arrange so-called reverse repurchase agreements with financial firms. The Fed would sell securities from its portfolio, taking cash out of the system, with an agreement to buy them back at a higher price later.

It could also offer 'term deposits' similar to certificates of deposit to banks. Bank funds held at the Fed in such instruments would not be available for lending.

In addition, the Treasury Department could issue securities and leave the funds on deposit with the Fed, or the Fed could sell some of the securities that it has accumulated. -- Reuters