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Central Bank Sends Out Warning To Investors: Surprises Will Come
The Federal Reserve want to raise interest rates at
some point in the future. And although there is no hurry, the central
bank is putting together its strategy despite some significant differences
of opinion inside the institution.
Fed Chairman Ben Bernanke, fresh from a controversial,
but still valid confirmation is about to set on a difficult campaign,
that of taking away the proverbial punch bowl of low interest rates
from the markets and the economy. According to The Wall Street Journal,
Mr. Bernanke will be using a new tool, "an interest rate the Fed pays
banks on money they leave on reserve at the central bank. Known as "interest
on excess reserves," this rate is now 0.25%."
The way this new device,
which Congress gave Mr. Bernanke in 2008 works, is this: "When the
Fed is ready to tap the brakes, it plans to raise the rate paid on
excess reserves, according to Fed officials in interviews and recent
speeches. The higher rate would entice banks to tie up money they
otherwise might lend to customers or other banks. The Fed expects
such a maneuver to pull up other key short-term rates, including the
federal-funds rate at which banks lend to each other overnight—long
the main tool for steering the economy."
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The higher rate would entice
banks to tie up money they otherwise might lend to customers
or other banks. The Fed expects such a maneuver to pull up other
key short-term rates, including the federal-funds rate at which
banks lend to each other overnight—long the main tool for steering
the economy."
But the use of this new tool does not guarantee an easy road for the central
bank, the markets, or the economy. As the Journal points out, when the Fed finally
tightens it will be start the reversal of a significant amount of monetary easing,
thus, "Extricating itself from these actions will require both skill and luck:
If the Fed moves too fast, it could provoke a new economic downturn; if it waits
too long, it could unleash inflation, and if it moves clumsily it could unsettle
markets in ways that disrupt the nascent economic recovery. Mr. Bernanke and
his colleagues are attempting to explain—both to markets and the public—that
the Fed has an exit strategy in the works in order to bolster confidence in its
ability to steer the economy."
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