Bernanke provokes mystery over Fed stimulus exit
US central Bank Federal Reserve Chairman Bernanke said that it’s worth discussing whether the Fed should use guidance on how long it plans to hold its securities as a “substitute” for assetpurchase stimulus.
When Ben S. Bernanke asserted that the Federal Reserve doesn’t ever have to sell assets, he raised questions about how the central bank can withdraw its record monetary stimulus without stoking inflation. The Fed may decide to hold the bonds on its balance sheet to maturity as part of a review of the exit strategy Bernanke expects will be done “sometime soon,” he told lawmakers in Washington on Feb. 27. This would help address concerns that dumping assets on the market will lead to a rapid rise in borrowing costs. It also allows the Fed to avoid realizing losses on its bond holdings as interest rates climb.
Removing asset sales from the exit plan Fed officials agreed to in June 2011 means the central bank would stop prices from accelerating by relying primarily on its ability to pay interest on the cash it holds for banks. Given that the Fed’s total assets have reached an unprecedented level of more than $3 trillion, leaving them untouched when the economy picks up may stoke inflation, according to Dean Maki, chief U.S. economist at Barclays Plc in New York. “If the Fed doesn’t withdraw quickly enough, there’s a risk of overshooting,” Maki said. “If the Fed gets rates back to a typical level and the economy is back to what’s regarded as normal, does having an expanded balance sheet have a notable effect on the economy, on asset markets, even once rates are nor- malized? We haven’t really had that situation in the U.S. before.”
No country has ever had a comparable increase in the size of its portfolio and unwound it “in the precisely analogous way,” Bernanke said in response to questions from members of the House Financial Services Committee. Japan was the only nation to use asset purchases, or quantitative easing, before the U.S. and is “still in that situation,” he said. The Fed isn’t planning an immediate exit and continues to add to its stimulus, buying $85 billion of mortgage-backed securities and Treasuries each month. It has left the duration and size of the program open-ended.
Policy makers in December linked their benchmark borrowing cost to economic indicators for the first time, pledging to hold the rate near zero as long as projected inflation isn’t more than 2.5 percent and joblessness exceeds 6.5 percent. Unemployment was 7.7 percent in February.
Still, the tools the U.S. central bank plans to employ, such as paying interest on reserves, “have been used quite frequently by central banks and they seem to work,” Bernanke told the House committee. The Fed finances the expansion of its portfolio by creating bank reserves. While policy makers gained the ability to pay interest on this cash in 2008, they’ve never used it to tighten policy.
Under the current exit strategy, the Fed would cease reinvesting some or all principal payments from its securities, revise its interest-rate outlook, raise the federal funds rate and then start selling housing debt to eliminate it from its holdings in three to five years.