Bernanke sees some economic gain, reviews Fed exit strategy

July 21, 2009

Federal Reserve Chairman Ben BernankeBy Mark Felsenthal and Alister Bull

WASHINGTON, July 21 (Reuters) – Federal Reserve Chairman Ben Bernanke on Tuesday said the outlook for the long-suffering U.S. economy appears to be improving and the U.S. central bank was carefully reviewing ways to withdraw its massive monetary policy stimulus when conditions permit.
But Bernanke cautioned that unemployment was likely to remain high into 2011, and he warned that this could sap fragile consumer confidence and potentially undermine what is expected to be a very gradual recovery.
“The (Fed) believes that a highly accommodative stance of monetary policy will be appropriate for an extended period,” Bernanke said in remarks prepared for delivery to the House of Representatives Financial Services Committee.
“However, we also believe that it is important to assure the public and the markets that the extraordinary policy measures we have taken in response to the financial crisis and the recession can be withdrawn in a smooth and timely manner as needed, thereby avoiding the risk that policy stimulus could lead to a future rise in inflation,” he said.
The blue chip Dow Jones industrial average pared gains, while the S&P 500 turned negative after Bernanke’s testimony was released. U.S. government debt prices turned positive, while the dollar extended losses against the yen.
“The Fed has zero intention of tightening monetary policy any time in the near future. They want to keep the conditions in place to sustain this fragile economic recovery,” said Boris Schlossberg, director for currency research at GFT Forex in New York.
The Fed has cut interest rates to almost zero and doubled the size of its balance sheet to around $2 trillion as it pumped money into the economy to fight a severe recession after a financial panic last year cracked global credit markets.
Some economists, including some policy-makers, have worried that this dramatic expansion of Fed liquidity and lending may have sown the seeds for inflation to blossom as the recovery gains traction.
Bernanke, delivering the Fed’s semiannual report to Congress on the economy, took pains to promise the U.S. central bank had an array of weapons at its disposal to withdraw its unprecedented monetary stimulus when the time was right, even if its balance sheet remains large for a time.
“The (Fed) has been devoting considerable attention to issues relating to its exit strategy, and we are confident that we have the necessary tools to implement that strategy when appropriate,” he said, echoing comments he made in an article published late on Monday on the Wall Street Journal’s website.
“Should economic conditions warrant a tightening of monetary policy before this process of unwinding is complete, we have a number of tools that will enable us to raise market interest rates as needed,” Bernanke said.
Paying interest on the reserves banks hold at the Fed — a tool used by other central banks — is chief among these devices, Bernanke said. By raising the amount of interest it is willing to pay, the Fed can encourage banks to park excess cash at the central bank.
The Fed’s monetary policy report also detailed a number of other measures policy-makers could employ, steps Bernanke had also outlined in his newspaper piece.
The report said the Fed could arrange so-called reverse repurchase agreements with financial firms. The Fed would sell securities from its portfolio, taking cash out of the system, with an agreement to buy them back at a higher price later.
It could also offer “term deposits” similar to certificates of deposit to banks. Bank funds held at the Fed in such instruments would not be available for lending.
In addition, the Treasury Department could issue securities and leave the funds on deposit with the Fed, or the Fed could sell some of the securities it has accumulated.

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