Wednesday, February 10, 2010
Another huge snowfall in the nation's capital prevented Fed Chairman Ben Bernanke from delivering this speech before the House Financial Services Committee today, but it was posted on the central bank's website anyway.
In it, plans are detailed for withdrawing the massive amount of monetary stimulus that has been injected into the U.S. financial system over the last two years, the new pillar of monetary policy being the rate of interest paid on excess bank reserves, a mechanism that Fed historian Allan Meltzer says won't work as noted here a couple weeks ago.
The FOMC anticipates 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. The Federal Reserve has a number of tools that will enable it to firm the stance of policy at the appropriate time.Aside from the economic populism that is now sweeping the country, where both elected officials and their constituents want to get some idea of how we might avoid a Weimar Germany outcome if we are lucky enough to prevent the Great Recession from turning into another Great Depression, you have to wonder why they're even talking about this now.
Most importantly, in October 2008 the Congress gave the Federal Reserve statutory authority to pay interest on banks' holdings of reserve balances. By increasing the interest rate on 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. Actual and prospective increases in short-term interest rates will be reflected in turn in longer-term interest rates and in financial conditions more generally.