By Steven K. Beckner
(MNI) – Federal Reserve Chairman Ben Bernanke said Thursday that
the economy continues to need “the support of accommodative monetary
policies” after echoing the Federal Open Market Committee’s judgment
last week that the federal funds rate will need to stay very low “for an
extended period.”
Bernanke said the Fed will need to begin tightening policy at some
point but only “as the expansion matures.”
Reprising and updating testimony on the Fed’s “exit strategy”
before the House Financial Services Committee, Bernanke said the Fed has
the tools to drain reserves from the banking system and push up
short-term interest rates, but said the actual combination and
sequencing of those tools will depend on how economic and financial
developments unfold.
He made clear that the Fed is in no hurry to reduce the size of its
balance sheet by selling assets, indicating that the Fed will first rely
on reverse repurchase agreements and term deposits to drain potentially
“hundreds of billions of dollars” worth of reserves without reducing the
balance sheet.
Reverse repos have already been tested and extended to transactions
with money market funds, and Bernanke said a term deposit facility will
be tested sometime this Spring.
He again stressed that the Fed’s Feb. 18 discount rate hike was
neither a monetary tightening move, nor a signal of impending
tightening.
In his Feb. 10 testimony, which was not presented to the committee
in person because of a severe East Coast snow storm, Bernanke said,
“Although at present the U.S. economy continues to require the support
of highly accommodative monetary policies, at some point the Federal
Reserve will need to tighten financial conditions by raising short-term
interest rates and reducing the quantity of bank reserves outstanding.
We have spent considerable effort in developing the tools we will need
to remove policy accommodation, and we are fully confident that at the
appropriate time we will be able to do so effectively.”
Bernanke’s latest prepared testimony did not greatly differ: “The
economy continues to require the support of accommodative monetary
policies. However, we have been working to ensure that we have the tools
to reverse, at the appropriate time, the currently very high degree of
monetary stimulus. We have full confidence that, when the time comes, we
will be ready to do so.”
The Fed chief noted that at its meeting last week, “the FOMC
maintained its target range for the federal funds rate at 0 to 1/4
percent and indicated that it continues to anticipate that economic
conditions, including low rates of resource utilization, subdued
inflation trends, and stable inflation expectations, are likely to
warrant exceptionally low levels of the federal funds rate for an
extended period.”
“In due course, however, as the expansion matures, the Federal
Reserve will need to begin to tighten monetary conditions to prevent the
development of inflationary pressures,” he continued. “The Federal
Reserve has a number of tools that will enable it to firm the stance of
policy at the appropriate time.”
Bernanke noted that the Fed has closed all of its emergency lending
windows, except for its Term Asset-Backed Securities Loan Facility
(TALF). The TALF is due to stop financing purchases of older or “legacy”
commercial mortgage backed securities at the end of March and new CMBS
at the end of June.
He reiterated that the Fed is due to conclude its purchases of
agency and agency-guaranteed mortgage backed securities a the end of
March.
Bernanke said that “both the closure of our emergency lending
facilities and the adjustments to the terms of discount window loans are
responses to the improving conditions in financial markets.”
“They are not expected to lead to tighter financial conditions for
households and businesses and hence do not constitute a tightening of
monetary policy, nor should they be interpreted as signaling any change
in the outlook for monetary policy,” he emphasized.
Bernanke again indicated that the Fed will rely heavily on its
ability to raise the rate of interest it pays on reserves when the time
comes to tighten policy.
“By increasing the interest rate on banks’ reserves, the Federal
Reserve will be able to put significant upward pressure on all
short-term interest rates, as banks will not supply short-term funds to
the money markets at rates significantly below what they can earn by
holding reserves at the Federal Reserve Banks,” he said. “Actual and
prospective increases in short-term interest rates will be reflected in
turn in higher longer-term interest rates and in tighter financial
conditions more generally.”
But Bernanke suggested that eventual increases in the IOER may well
be accompanied, if not proceeded, by reserve drains to firm up the funds
market in advance of IOER rate hikes.
“The Federal Reserve has also been developing a number of
additional tools it will be able to use to reduce the large quantity of
reserves currently held by the banking system,” he said. “Reducing the
quantity of reserves will lower the net supply of funds to the money
markets, which will improve the Federal Reserve’s control of financial
conditions by leading to a tighter relationship between the interest
rate paid on reserves and other short-term interest rates.”
In addition to its expanded reverse repo capability, the Fed is
“also developing plans to offer to depository institutions term
deposits, which are roughly analogous to certificates of deposit that
the institutions offer to their customers,” he said. “After a revised
proposal is reviewed by the Board, we expect to be able to conduct test
transactions this spring and to have the facility available if necessary
thereafter.”
“The use of reverse repos and the deposit facility would together
allow the Federal Reserve to drain hundreds of billions of dollars of
reserves from the banking system quite quickly, should it choose to do
so,” he added.
Bernanke explained that “when these tools are used to drain
reserves from the banking system, they do so by replacing bank reserves
with other liabilities; the asset side and the overall size of the
Federal Reserve’s balance sheet remain unchanged.”
Bernanke said the Fed could also reduce the size of the balance
sheet and tighten policy by redeeming or selling securities, but
suggested that is not a priority.
“The redemption or sale of securities would have the effect of
reducing the size of the Federal Reserve’s balance sheet as well as
further reducing the quantity of reserves in the banking system,” he
said. “Restoring the size and composition of the balance sheet to a more
normal configuration is a longer-term objective of our policies.”
“In any case, the sequencing of steps and the combination of tools
that the Federal Reserve uses as it exits from its currently very
accommodative policy stance will depend on economic and financial
developments and on our best judgments about how to meet the Federal
Reserve’s dual mandate of maximum employment and price stability,” he
added.
** Market News International **
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