The Federal Reserve could begin pulling back its unprecedented stimulus for the U.S. economy by first removing some cash from the financial system and then raising interest rates, Fed Chairman Ben Bernanke said Wednesday.
The U.S. central bank has pumped more than $1 trillion 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 is at a lofty 9.7 percent. 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.
So, what Bernanke will do is largely reverse everything he's done over the last couple years. Right now, the Fed Funds Rate is at zero. He will raise that though he hasn't indicated how high.
Beyond that, he'll sell back most, if not all, of the bonds that he's bought over the last couple years.
This will of course increase interest rates significantly. Tightening the money supply will also stunt economic growth. What most people aren't talking about is what this constant yo yo monetary policy does to long term economic growth. Bernanke spent 2007-2008 furiously lowering rates. He spent the next year furiously increasing the money supply. Now, in 2011, he'll just as furiously do the opposite. Greenspan did something similar in 1999-2003 in which he furiously raised and then lowered rates. This sort of schizophrenic interest policy stunts long term growth, encourages bubbles, and creates chaos and confusion. Monetary policy is a powerful thing but used too liberally it can cause disaster.