–Rates Apt to Stay ‘Exceptionally Low … For Extended Period’
By Steven K. Beckner
WASHINGTON (MNI) – Federal Reserve Chairman Ben Bernanke held out
the possibility that the Fed might do more to boost a sluggish economy
Wednesday, even while talking about the eventual need to remove monetary
stimulus and return to a more normal central bank balance sheet.
Bernanke, delivering the Fed’s semi-annual Monetary Policy Report
to Congress before the Senate Banking Committee, said the Federal Open
Market Committee expects “moderate” growth, a “gradual” reduction in
unemployment and “subdued” inflation.
But the Fed chief described the economic outlook as “unusually
uncertain” as he presented a report that contained downwardly forecasts
by Fed governors and Federal Reserve Bank presidents. As he has numerous
times before, he cast a wary eye on weak job markets and credit market
constraints, and he reiterated the FOMC’s concern that financial
conditions have become “less supportive” of growth in wake of the
European debt crisis.
Bernanke said the Fed will need to tighten policy “at some point”
and outlined the way it is apt to proceed “when the time comes.”
But against a “moderate” and “uncertain” economic backdrop,
Bernanke not only reiterated the FOMC’s judgment that the near zero
federal funds rate will likely need to stay “exceptionally low…for an
extended period,” he went further: “we remain prepared to take further
policy actions as needed.”
Bernanke said the FOMC has been “discussing alternatives” for
getting the Fed’s bloated balance sheet back to a normal size and
composition, but made clear that this is not something on the near-term
horizon. Any asset sales would be done “gradually” and be announced
“well in advance,” he said.
Bernanke said the economy is growing at a “moderate pace.” And
while it will be getting “less impetus” from fiscal stimulus and
inventory restocking, he said it should benefit from “rising demand from
households and business.”
But he heavily qualified that upbeat characterization. He said “the
housing market remains weak,” and he added, “An important drag on
household spending is the slow recovery in the labor market and the
attendant uncertainty about job prospects.”
“In all likelihood, a significant amount of time will be required
to restore the nearly 8-1/2 million jobs that were lost over 2008 and
2009,” he added.
What’s more, while financial conditions have “improved
significantly,” he said “many banks continue to have a large volume of
troubled loans on their books, and bank lending standards remain tight.”
“With credit demand weak and with banks writing down problem
credits, bank loans outstanding have continued to contract,” he
continued. “Small businesses, which depend importantly on bank credit,
have been particularly hard hit.”
He reiterated that the Fed is “working to facilitate the flow of
funds to creditworthy small businesses.”
Speaking on behalf of his colleagues, Bernanke said, “the FOMC
continues to anticipate that economic conditions are likely to warrant
exceptionally low levels of the federal funds rate for an extended
period.”
“At some point, however, the Committee will need to begin to remove
monetary policy accommodation to prevent the buildup of inflationary
pressures,” he said, adding, “When that time comes, the Federal Reserve
will act to increase short-term interest rates by raising the interest
rate it pays on reserve balances that depository institutions hold at
Federal Reserve Banks.”
“To tighten the linkage between the interest rate paid on reserves
and other short-term market interest rates, the Federal Reserve may also
drain reserves from the banking system,” he went on, noting that the Fed
has been testing reverse repurchase agreements with an expanded set of
counterparties and a new term deposit facility to absorb reserves.
But he added a caveat: “Of course, even as the Federal Reserve
continues prudent planning for the ultimate withdrawal of extraordinary
monetary policy accommodation, we also recognize that the economic
outlook remains unusually uncertain.”
“We will continue to carefully assess ongoing financial and
economic developments, and we remain prepared to take further policy
actions as needed to foster a return to full utilization of our nation’s
productive potential in a context of price stability,” he added.
Bernanke said the Fed’s “quantitative easing” policy of buying
$1.75 trillion in Treasury securities, agency debt and agency-backed
mortgage backed securities “helped improve conditions in mortgage
markets and other private credit markets and put downward pressure on
longer-term private borrowing rates and spreads.”
That asset purchase program not only increased the size of the
balance sheet from $80 billion to $2 trillion, it transformed it from a
portfolio of 100% Treasury securities to one that is almost two-thirds
invested in agency-related securities. And the average maturity of the
Treasury portfolio nearly doubled, from three and one-half years to
almost seven years.
Bernanke said “the FOMC plans to return the System’s portfolio to a
more normal size and composition over the longer term,” and he said “the
Committee has been discussing alternative approaches to accomplish that
objective.”
He said “one approach is for the Committee to adjust its
reinvestment policy — that is, its policy for handling repayments of
principal on the securities — to gradually normalize the portfolio over
time.”
“Currently, repayments of principal from agency debt and MBS are
not being reinvested, allowing the holdings of those securities to run
off as the repayments are received,” he said. “By contrast, the proceeds
from maturing Treasury securities are being reinvested in new issues of
Treasury securities with similar maturities.”
“At some point, the Committee may want to shift its reinvestment of
the proceeds from maturing Treasury securities to shorter-term issues,
so as to gradually reduce the average maturity of our Treasury holdings
toward pre-crisis levels, while leaving the aggregate value of those
holdings unchanged,” he said.
Bernanke emphasized that “at this juncture, however, no decision to
change reinvestment policy has been made.”
“A second way to normalize the size and composition of the Federal
Reserve’s securities portfolio would be to sell some holdings of agency
debt and MBS. Selling agency securities, rather than simply letting them
run off, would shrink the portfolio and return it to a composition of
all Treasury securities more quickly,” Bernanke said.
He said “FOMC participants broadly agree that sales of
agency-related securities should eventually be used as part of the
strategy to normalize the portfolio. Such sales will be implemented in
accordance with a framework communicated well in advance and will be
conducted at a gradual pace.”
“Because changes in the size and composition of the portfolio could
affect financial conditions, however, any decisions regarding the
commencement or pace of asset sales will be made in light of the
Committee’s evaluation of the outlook for employment and inflation,” he
added.
** Market News International Washington Bureau: 202-371-2121 **
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