Federal Reserve 2010 Monetary Policy -- a gingerly step towards tightening
0 
In his semi-annual report to Congress, Federal Reserve Chairman Ben Bernanke listed a number of tools that the Fed has implemented or will implement to take "excess liquidity" out of the financial system.
Federal funds rate remains current level
The Fed increased the discount rate by 25 basis points on Feb. 18 and is scheduled to close the Term Asset-Backed Securities Loan Facility, including newly issued commercial mortgage-backed securities (CMBS) on June 30.
All of the adjustments only suggest that the US financial system has been healing and moving toward stabilization, but the broader domestic economy has not yet gotten out of the woods.
"The federal funds rate is likely to remain exceptionally low for an extended period," Bernanke said, implying that a rate increase is still premature.
The move incurred many critics and comments by the public and even policy makers. Kansas City Fed President Thomas Hoenig criticized Bernanke's decision during an interview with CNBC on Tuesday, saying "The Federal Reserve should raise interest rates sooner rather than later."
"We should not be giving guarantees to certain sector and failing to raise rates due to this problem will only invite speculations and future excess," Hoenig said.
In fact, Bernanke's decision was not totally unexpected. Analysts had earlier predicted that the Fed would keep the federal funds rate at its current level until this summer, and the earliest interest rate increase would not happen until the fourth quarter of this year.
After all, with the unemployment rate currently close to 10 percent, any rush to raise interest rates will not only affect America's fragile economic recovery, but also increase the cost of US debt.
Moreover, decreasing wages caused by the high unemployment have helped to delay the arrival of inflation, leaving no immediate urgency for a rate hike.
Under the current monetary policy, the stock market is less likely to have a second dip in the short term before excess liquidity is drained out of the system and carry trades completely wind down.
Cautious increase of federal funds rates
Even if the Fed decides to raise the federal funds rate before the end of the year, it is less likely to see a similar increase to what took place in Australia.
In the interests of the US, maintaining a low rate will keep its currency more competitive in terms of stimulating exports and increasing the trade surplus, thereby increasing employment.
Moreover, a weak dollar can reduce the cost of debt for the United States.
The Fed recently had a tough time auctioning its 30-year bonds, which will likely cause the United States to pay nearly 60 million US dollars in additional interest.
A dramatic rate increase will certainly increase the cost for the US debt. Therefore, the Fed will take that into consideration when it gingerly tightens monetary policies this year.
Why is fed in a dilemma
On one hand, having experienced the scenario of "pumping money into the system" in 2008 and 2009, Bernanke has already exhausted the tools of implementing an effective monetary policy.
Meanwhile, he has to map out an "exit strategy" in terms of how to tighten the money supply to prevent inflation, asset bubbles, and speculation caused by low-cost loans.
On the other hand, high unemployment, a staggering economy still in recovery, and mounting deficits have restricted Bernanke from raising interest rates anytime soon.
Therefore, Hoenig's criticism seems a bit harsh because what Bernanke could do at this stage is exactly what he laid out in the report:
"Although the federal funds rate is likely to remain exceptionally low for an extended period, the Federal Reserve will at some point need to begin to tighten monetary conditions to prevent the development of inflationary pressures," he said.
Bernanke has to show his sensitivity about fighting the longer-term inflation and maintaining stable prices to protect tax payers' interests in front of the public. But the Fed's actions indicate that it is not yet ready to begin a large-scope tightening of credit that would affect businesses and consumers.
Go to Forum >>0 Comments