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Snippet from Federal Reserve Protects Its Turf For Fear Of Getting Eclipsed


Snippet from Federal Reserve Protects Its Turf For Fear Of Getting Eclipsed

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Bernanke’s emphasis that “economic conditions are not likely to warrant tighter monetary policy for an extended period” might reassure bond buyers, but a closer examination of his four point exit strategy leads to inflation.

Here’s how Bernanke intends to keep the fed funds rate at nearly zero while attempting to reduce reserves and drain excess market liquidity, and why it won’t work:

1. “Arrange large-scale reverse repurchase agreements.” The problem is that repo agreements only temporarily withdraw money from the system.

2. The Fed has to stop monetizing the debt, not “take care to ensure that we can achieve our policy objectives without reliance on the Treasury.” The sale of massive amounts of treasuries alone could mop up substantial excess liquidity.

3. Bernanke wants to “offer term deposits to banks,” similar to bank CDs to customers. In order to get banks to participate, the Fed would have to offer banks a high enough interest rate equivalent to the current commercial paper rate plus a high enough spread to make the transaction profitable.

4. “Selling a portion of the Fed’s holdings of long-term securities into the open market” would be the fastest way for the Fed to ensure its demise. How does the Fed think the public would react to the central bank incurring huge losses on securities purchased when interest rates were extraordinarily low? Imagine Bernanke going back on 60 Minutes to say that the mortgages the Fed purchased with a 4.5% interest rate were sold when prevailing mortgages jumped to 6%, at least a 30% loss in value to taxpayers. The more practical approach would be just to let the Fed’s securities mature without renewing them, while the Treasury absorbs excess liquidity by financing the massive deficit.