U.S. Fed proposes creation of new exit tool

December 29, 2009

By Pedro Nicolaci da Costa

WASHINGTON, Dec 28 (Reuters) – The U.S. Federal Reserve on Monday proposed the creation of a new mechanism it could use to withdraw money from the banking system when the time comes to tighten monetary policy.

The mechanism, known as a term deposit facility, would allow financial institutions to earn interest on loans of longer maturities to the central bank. The Fed already pays interest on banks’ overnight reserves.

Rates on such loans could be determined at auction or via a specified formula, the Fed said. Their length would not exceed one year, but would most likely range from one to six months.

In its effort to battle the worst financial crisis since the Great Depression, the Fed has deployed an extraordinary array of emergency measures, leading to a surge in outstanding credit to the banking system to nearly $2.2 trillion.

These measures have fueled some concern about the possibility of high inflation, since withdrawing such reserves at just the right time is seen as crucial to preventing rapid growth in consumer prices.

Downplaying such fears, the Fed has argued it has the ability to remove this monetary stimulus in a timely fashion.

The latest proposal, which the Fed stressed did not represent any immediate move toward a less accommodative monetary policy, was expected to serve as an additional tool in the tightening arsenal, which also includes reverse repurchase agreements and outright sales of assets.

“The proposal is one component of a process of prudent planning on the part of the Federal Reserve and has no implications for monetary policy decisions in the near term,” the Fed said in a statement.

(Reporting by Pedro Nicolaci da Costa; Editing by Neil Stempleman)

((pedro.dacosta@thomsonreuters.com; +1 202 898-8300; Reuters Messaging: pedro.dacosta.reuters.com@reuters.net))

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/