Bernanke Outlines Exit Strategy

FEBRUARY 10, 2010
Bernanke Outlines Exit Strategy
By LUCA DI LEO
Federal Reserve Chairman Ben Bernanke outlined the likely path the Fed would take to tighten credit once the economy has recovered enough. In another step toward unwinding its crisis-lending programs, he said Wednesday the Fed could soon begin raising its discount rate, charging more for emergency loans it makes directly to banks.
In testimony prepared for a House Financial Services Committee hearing that was called off because of a blizzard in Washington, Mr. Bernanke said that another interest rate might for a time replace the federal-funds rate as the main policy tool. That's the rate the Fed pays to banks on excess reserves they leave at the central bank.
Mr. Bernanke said that though the economy needed support from monetary policy, the Fed would "at some point" increase short-term rates and drain some of the money it had pumped into the economy during the recession. He gave no hint that such a move was imminent.
Fed Chairman Ben Bernanke outlines a plan to pull back policies that have been propping up the economy. Dow Jones Newswires' Neal Lipschutz and WSJ's Sudeep Reddy join Kelsey Hubbard in the News Hub with more.
As part of its plans to wind down emergency liquidity measures, the Fed may "before long" increase the difference between the discount rate and the federal-funds rate, a Fed-influenced rate at which banks lend to each other overnight, he said. The spread between the rates is a quarter percentage point; before the crisis, it was a full point.
Mr. Bernanke's speech was designed to outline the Fed's strategy for withdrawing its extraordinary support for the economy, which has brought the federal-funds rate near zero and led the Fed to buy more than $1 trillion worth of U.S. Treasury and mortgage-backed securities. He said the sequencing and tools the Fed would use to tighten policy would depend on how the economic recovery develops.
The Fed chairman said he didn't currently anticipate the Fed would sell any of its holdings of long-term U.S. Treasurys or mortgage-backed securities "in the near term," and probably not "until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery." But over time, he said, "the Federal Reserve anticipates that its balance sheet will shrink toward more historically normal levels and that most or all of its security holdings will be Treasury securities."
A focus on the interest rate for excess reserves—now at 0.25%—would present markets with a new signal to follow when the Fed begins tightening credit. "It is possible that the Federal Reserve could for a time use the interest rate paid on reserves, in combination with targets for reserve quantities, as a guide to its policy stance," Mr. Bernanke said, adding no final decision had yet been made.
Raising the excess-reserves rate would give banks an incentive to park more funds at the Fed instead of lending them out to companies or households. In this way, the Fed would be able to restrain an economy that risks overheating and sparking inflation. Moving this rate would pull up other short-term rates, including the federal-funds rate, long the Fed's main tool for steering the economy.
While other major central banks, such as the European Central Bank, have been using interest on excess bank reserves for a while, it's a new tool for the Fed. Congress gave the central bank authority to use it in October 2008.
Mr. Bernanke says the Fed expects "it will eventually return to an operating framework with much lower reserve balances than at present and with the federal-funds rate as the operating target for policy."