Bernanke Presents Fed Exit Strategy

By:
Peter King | February 10, 2010

Federal Reserve Chair Ben Bernanke has laid out his “exit plan” for winding down the Fed’s economic stimulus efforts, saying he expects the Fed to begin raising interest rates before long.

Bernanke said he expects the Fed will soon consider a “modest increase” in the discount rate, which is the rate the Fed charges banks for short-term loans. He termed such a move part of a “further normalization” of Federal Reserve lending policies in response to improving financial markets and said it does not signal a change in monetary policy, nor should it result in tighter credit for consumers and businesses.
 
Bernanke made his comments in the form of prepared testimony that was to have been presented before the House Financial Services Committee today. The hearing was canceled due to the weather, but the Fed went ahead and released the text of Bernanke’s planned remarks anyway.
 
He said he expects that economic conditions, including subdued inflation and economic growth, will likely continue to warrant keeping rates unusually low for an extended period. However, he said the Fed is putting plans in place to be able to tighten monetary policy as economic growth picks up and inflationary pressures increase.
 
The Fed faces the problem of gradually backing off the massive stimulus it applied to the economy over the past year in order avoid triggering inflation while at the same time not cutting the legs out from under any nascent economic recovery. As a result, it has been exploring a variety of new, more nuanced approaches aside from its primary tool of simply adjusting the Federal Funds Rate, which effectively remains near zero.
 
One strategy the Fed is considering would be to raise the interest rate it pays banks on short-term funds they keep at the Fed, which would have the effect of nudging overall rates upward, since banks would not lend to each other for less than they could earn at the Fed. Bernanke said the Fed is likely to experiment with a variety of such approaches as it gradually winds down its stimulus efforts as the economy improves.

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