Bernanke Outlines Stimulus Exit Strategy

(CBS/AP)  Federal Reserve Chairman Ben Bernanke began Wednesday to outline the central bank's strategy for reeling in stimulus money once the U.S. economic recovery is more firmly rooted.

Bernanke said the Fed will likely start to tighten credit by boosting the interest rate it pays banks on money they leave at the central bank. Doing so would raise rates tied to commercial banks' prime rate and affect many consumer loans. Companies and ordinary Americans would pay more to borrow.

Bernanke's remarks on the Fed's eventual pullback of economic aid come despite signs that the global recovery remains fragile. Europe is trying to contain a debt crisis. And President Barack Obama is pushing for tax breaks to generate jobs.

But in his prepared remarks to a House committee, Bernanke indicated the Fed is still months away from raising rates or draining most of the stimulus money it injected to rescue the financial system. He said the recovery still needs support from record-low interest rates.

Under the threat of a major snowstorm, the panel postponed its hearing scheduled for Wednesday. The hearing was intended to review the Fed's plans for withdrawing its emergency supports. Bernanke chose to release the prepared testimony.

Snow Storm Bails Out Bernanke

The Fed chief used his remarks to explain how the central bank will try to withdraw the stimulus money without tipping the economy back into recession.

Using the rate it pays on banks' excess reserves to affect credit would be a new strategy for the Fed. Since the 1980's, its main lever to tighten or loosen credit has been the federal funds rate. That rate is now at a record low near zero.

The rate paid on banks' excess reserves is 0.25 percent. Boosting that rate would give banks an incentive to keep money parked at the Fed, rather than lend it.

It also would cause the funds rate to rise, economists say. Adjusting the interest paid on banks' excess reserves helps stabilize the funds rate when the financial system is awash in cash, as it is now.

Paying interest on the reserves is a relatively new tool for the Fed, having been authorized by a 2008 law. Many foreign central banks rely on it. The Fed started paying interest on the reserves at the height of the financial crisis in October 2008.

In his prepared remarks to the House Financial Services Committee, Bernanke lays out his most extensive details to date on the Fed's exit strategy from record-low rates and economic stimulus.

Deciding when and how to remove all the stimulus is the biggest challenge for Bernanke in his second term, which started last week. Reeling in the stimulus too soon risks short-circuiting the recovery. That could send unemployment up.

Yet the Fed keeps its stimulus measures in place for too long, they could help unleash inflation.

Jill Schlesinger, editor-at-large for CBS Moneywatch.com, is skeptical that the Fed can execute the proper timing for reeling in the credit market.

"The Fed's track record is abysmal when it comes to market timing. We now know that the Fed was slow to raise interest rate policy earlier in the decade, which helped fuel the housing and credit bubble. In fact, going back two decades, the Fed is notorious for being late on when it comes to tightening," Schlesinger wrote.

Bernanke repeated the Fed's pledge to hold rates at record lows for an "extended period." Economists think that means for at least six more months. But Bernanke cautioned that the Fed eventually will need to raise rates to ease inflationary pressures.

Even before the Fed raises the rate paid on banks' excess reserves, it could raise the rate it charges banks for emergency loans, Bernanke said. That rate, called the discount rate, is 0.50 percent. An increase in the discount rate wouldn't affect interest rates charged to consumers and businesses. But Bernanke said it would help normalize the Fed's interest rate policy now that the worst of the financial crisis has passed.

He said he expected the Fed to consider a "modest" increase to the discount rate. Such a move would not raise rates for households and businesses and would not signal any change in interest-rate policy, Bernanke said.

The Fed is still weighing the order of steps it can take to reel in the stimulus.

Under one scenario, the Fed would first use its tools to drain money from the financial system. Then it would start pushing up rates throughout the economy by boosting the rate paid on banks' excess reserves, Bernanke said.

But if a faster exit is needed, the Fed could raise the rate on reserves even as it's using its other tools to pull money from the financial system.

The Fed is fine-tuning one tool to withdraw money: By selling securities from its portfolio with an agreement to buy them back later. Those operations are called reverse repurchase agreements.

And the Fed is moving ahead on a proposal to let banks to set up the equivalent of certificates of deposit at the central bank. This, too, would help the Fed mop up money pumped into the economy and prevent inflation from flaring later.

Together, those two operations - reverse repos and the CD-like deposit accounts - would let the Fed "drain hundreds of billions of dollars of reserves from the banking system quite quickly, should it choose to do so," Bernanke said.

Bernanke said he doesn't expect the Fed to sell any of its securities anytime soon.

To fight the financial crises, the Fed pumped so much money into the economy for lending programs that its balance sheet swelled to $2.2 trillion - more than double the pre-crisis level. The Fed will need to mop up that money to prevent inflation later.

Bernanke said another economic support program aimed at driving down mortgage rates and bolstering the housing market is on track to end in March. By then, the Fed will have finished buying $1.25 trillion in mortgage securities from Fannie Mae and Freddie Mac. It will also have finished buying $175 billion in debt from the mortgage giants.

But the Fed hasn't ruled out continuing to buy mortgage securities after then to support the economy.

[javierlundy]

The fact of the matter is that no one knows the outcome. Particularly, no one on this forum knows whether inflation will be quick enough and strong enough for higher interest rates to dampen a mild recovery by killing demand, then tipping us into another recession.

____________
http://www.cheap-credit-cards.org

[cvillani1958]

Good evening,
I am new to this thread, but before you can understand what is going on in our economy you must know what the Federal Reserve Bank is, who owns it and why the government must protect it, (question of the moment What was the TARP act of 2008? Who did it protect?). You MUST read the Creature from Jekyll Island by G. Edward Griffin. After finishing this book you will have a solid foundation to understand the current state of our economy and help protect yourselves from what is coming. Bernanke is not the problem, it IS the Federal Reserve and the tweleve families who own the Fed, they are from England, Germany and the US. Read it and understand.
This process started in 400BC and continues today. The dollar depreciates. Central planning increases. Information becomes more distorted. This will end badly. Worse, it may start over.

[flsunjnky]

Ha jgg, that was Bush's way into it. Guess we just need to leave it at that?

[jgg000101]

lemme guess: the way to get out of it is to spend a trillion dollars?

[wfw3536]

It is too bad Obama recommended this guy to another term when he is in bed with big banks. If Bernanke would have done his job we wouldn't be in this mess. Another mistake of this administration. Instead of taking the money they are getting back from the banks Obama wants to use this money for other spending when the bill that was passed specifically states the money must not be spent for other purposes. Is this administration out of control or what.

[rykatspop]

Hey Bernanke (liar for banks), if you want to help stimulate the economy for Main Street America, then tell the Wall Street banks to back off on the association representing credit unions in America. A number of credit unions are fighting the banks (their lobbyists) for the right to make loans to small businesses. BUT what are the banks trying to do? They're telling Congress NOT to allow credit unions to make SMALL LOANS and MORTGAGES to consumers in this area of finance. Why? BECAUSE THERE IS A GROWING DEMAND BY ORDINARY AMERICANS AND SMALL BUSINESSES FOR THIS KIND OF FINANCING.

Gee, all those Repugs and Blue Democrats yell and stomp their feet about FREE MARKETS and COMPETITION, but do very little to promote their cherished lie about PROMOTING A FREE MARKET where competition brings efficiency, cost control and innovation. Yeah, WHY ARE THE BANKS, LOBBYISTS AND CONGRESS WORKING SO HARD TO STIFLE INNOVATION NOW???!!!! WOULDN'T THIS BE A WAY TO HELP ORDINARY AMERICANS AND BUSINESSES TO GET BACK ON THEIR FEET? TO CREATE JOBS? HELLO, CREATE JOBS BY ALLOWING CREDIT UNIONS TO MAKE BUSINESS LOANS, ETC!!!! Come on boys, where's your hutzpa now? Where is all that talk about capitalism being the king? ARE YOU SOCIALISTS ALL OF THE SUDDEN???!!!!!!!!!!!!!!!! YOU MAKE ME SICK. I WANT TO PUKE AT YOUR SELF-SERVING COWARDICE BETRAYAL ON AMERICANS.

HYPOCRITES!!!!!! LIARS!!!!!! THIEVES!!!!!!!! CROOKS!!!!!!!

[rykatspop]

BINGO!!! We don't have to rocket scientists (or accountants) to figure this one out. Well said.

[jtdev1]

He means to say:

They will raise the interest rate once the Banks have made all their money back from the near zero rate now.

You know those banks are getting the money for next to nothing and loaning it out for a huge profit... How else do you think they are getting those bonus monies from???

[pragmatist1]

If Bernanke and the committee can work, so should the rest of the DC fed employees, snow or not.

[hologram5]

This guy is a toolshed and was in part one of the reasons we are where we are at today. Get rid of him. I am still amazed that he got a second term. Unbelievable.

[sean56v]

Obama makes a good move recovering money lent-out under his program. The cash is available. He could reduce budget red ink. Barack must consider his next state of the union speech. In January of 2011, it matters that the president reports a significant elimination of deficit spending.