The Exit Strategy

Federal Reserve Chairman Ben Bernanke recently laid out his plans to lawmakers on how the Fed will eliminate programs, when needed, which pumped hundreds of billions of dollars into the financial system. In an op-ed piece for the Wall Street Journal, he wrote that the strategy is ready to be put to use, but noted that “accommodative policies will likely be warranted for an extended period,” meaning the exit strategies may not be implemented any time soon.
In his article however, Chairman Bernanke did not mention that steps by the government to remove earlier emergency support to the short-term credit markets have actually been in progress for several months now. Although we concur that an increase in the Fed funds rate will probably not happen until some time next year, we also think the pullbacks by the Fed, the FDIC, and the Department of Treasury are indicative of a stabilizing financial system and of better growth prospects for the economy. We welcome these developments and view them as important interim steps toward a more normalized environment for credit investing.

The Bernanke Exit Strategy

Chairman Bernanke explained that the Fed’s approach to shrinking its balance sheet without raising interest rates will be done through bank lending. In a recovery scenario, bank lending drains the banks’ reserve balances at the Fed, thus helping the various lending facilities to wind down. In addition, the Fed has two broad means of tightening monetary policy. First, by raising interest rates paid on reserve balances (currently at 0.25%) and second, by taking action that reduces the stock of reserves.
The interest rate the Fed pays on reserve balances, argues the Chairman, should put a floor under short-term market rates, including the federal funds rate. Raising the rate also discourages excessive growth in money or credit because banks will not want to lend out their reserves at rates below what they can earn at the Fed.
The Fed’s strategy of reducing reserves includes arranging large-scale reverse repurchase agreements with financial counterparties and allowing the Treasury Department to sell T-bills, the proceeds of which would be deposited with the Federal Reserve. In both cases, when purchasers pay for the securities, cash leaves the financial system and the central bank mops it up. Other ways to drain money supply could include offering Federal Reserve term deposits to banks or selling its holdings of long-term securities into the open market.
DOWNLOAD FULL REPORT

Our research is for personal, non-commercial use only. You may not copy, distribute or modify content contained on this Website without prior written authorization from Capital Advisors Group. By viewing this Website and/or downloading its content, you agree to the Terms of Use.