MercoPress. South Atlantic News Agency

Bernanke announces Fed ready to remove liquidity and prepare for rate hikes

In spite of the Washington blizzard, the Fed made the (suspended) testimony before Congress public

The Federal Reserve could begin pulling back its unprecedented stimulus for the US economy by first removing some cash from the financial system and then raising interest rates, Fed Chairman Ben Bernanke said.

The US central bank has pumped more than one trillion USD into the economy after it slashed benchmark rates to near zero to combat the worst financial crisis since the Great Depression.

While the economy has grown for the past two quarters, unemployment remains at 9.7% In his most detailed description to date of how the Fed aims to dismantle the extensive emergency support facilities it put in place during the crisis, Bernanke made clear the Fed's thinking on its exit strategy had advanced even though the time for tightening monetary policy was still some ways away.

“Although at present the U.S. economy continues to require the support of highly accommodative monetary policies, at some point the Federal Reserve will need to tighten financial conditions,” Bernanke said in remarks prepared for a hearing of the House of Representatives Financial Services Committee.

The hearing was postponed because of heavy snow that shut down transportation in Washington, but the Fed decided to go ahead and make Bernanke's testimony public.

Bernanke said exit steps include the likely widening, soon, of the gap between the discount rate the Fed charges banks for emergency loans and the overnight inter-bank federal funds rate, its main policy tool. The Fed pulled the discount rate closer to the fed funds rate during the severe credit crunch to encourage banks to use it to obtain short-term funding.

U.S. stock indexes read the Fed chairman's comments as hinting at a rise in interest rates and added to losses, while the dollar gained against the dollar and the yen.

Bernanke said the Fed could begin by testing tools to absorb the massive amount of reserves it had pumped into the banking system, such as reverse repurchase agreements and term deposits for banks at the central bank, in small amounts to prepare markets, Bernanke said.

As the time to tighten financial conditions drew nearer, the Fed could ramp up reserve-draining operations. Shrinking the central bank's bloated balance sheet would give policymakers tighter control over short-term interest rates, Bernanke said.

Ultimately, the Fed would increase the rate it pays on reserves banks hold at the central bank as its way to take its foot off the wide-open monetary accelerator pedal. Raising the interest rate on reserves would encourage banks to park funds with the Fed, taking the money out of circulation.

The Fed has greatly expanded its balance sheet with purchases of mortgage-related debt as part of its efforts to revive the economy. Those mortgage-related assets are on track to total $1.45 trillion by the end of March, when the buying is due to end.