By Steven K. Beckner

LEXINGTON, Va. (MNI) – The Federal Reserve’s testing of reserve
draining tools should not be taken as a signal of impending monetary
tightening, New York Federal Reserve Bank President William Dudley said
Thursday, as he reiterated that the federal funds rate is likely to stay
“exceptionally low … for an extended period.”

Dudley, vice chairman of the Fed’s policymaking Federal Open Market
Committee, said the Fed may do “fairly large” testing of reverse
repurchase agreements before the FOMC’s changes the “extended period”
language. But he said no decision has yet been made on the sequencing of
steps the Fed will take on the road to eventual tightening.

Talking to reporters following a speech at Washington and Lee
University, Dudley said that “as of right now,” the Fed has stopped
buying agency mortgage-backed securities. But he did not completely rule
out a resumption of such purchases, saying that would depend on how
economic conditions evolve.

In earlier responses to audience questions, Dudley said that
“within a few months, if not tomorrow, we will start to see employment
gains.” But as he had in formal remarks he reiterated that the funds
rate, which has been in the zero to 25 basis point range since December
2008, will likely stay there “for an extended period.”

He said the recovery is apt to be “quite subdued,” and said “time
is just going to have to pass” for the economy to work off “excesses” in
the housing market and “gradually cure itself.”

After reviewing for students how the Fed has been preparing exit
tools such as reverse repos and a forthcoming term deposit facility,
Dudley emphasized that “you shouldn’t take as a signal us tightening
policy from testing tools.”

He said the Fed has been busy preparing its tools because it want
them to be “available as soon as needed.”

Asked by a reporter whether the Fed would likely do reverse repos
before it changes the “extended period,” Dudley replied, “I would expect
us to do testing, and testing could be fairly large.” But he said, “we
have not made any decisions about sequencing” of reserve draining
operations and language changes.

Regarding the risks of an inflationary credit expansion, Dudley
said the Fed can raise the rate it pays on excess reserves to
incentivize banks to keep holding reserves with the Fed rather than
lending them into the economy. And he said the proposed term deposit
facility likewise would “induce banks rather than hold reserves with us
on an overnight basis to set up term deposits and hold deposits with
us.”

He said that the Fed could implement that program “as soon as
needed.”

In other comments, Dudley said it was “appropriate” to run large
budget deficits during the recession, but added, “there is no question
that the U.S. can’t run very large fiscal deficits indefinitely…There
is going to have to be an exit from this period of fiscal stimulus.”

He said a “credible” and “timely” fiscal exit plan is needed.

** Market News International **

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