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Wednesday, February 10, 2010

The Fed in Reverse?

Fed Chairman Ben Bernanke has signaled what he will do to make sure that his loose money policy won't create hyper inflation.

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.

1 comment:

Gil said...

There is no way that Brnanke will revers course. It will not happen ever.

There is an estimated $400-$600 trillion in derivatives on the planet half of which are in the us.

The mere puff of a hint of interest rate increase and hoouses will be worth 10% of what they are worth today and the Dow will be at 500.

There is no way out of this mess. The Fed has no practical way of draining liquidity out of the system because there are too many banks that are not under the Feds group of banks. The Fed has no authority over them.

In addition, political realities dictate that the Fed keeps printing. They just will not stop.

This reversal is a total pipe dream. As a matter of fact gold is due to hit $1500 in the next few months which means that the Fed is printing until the dollar will be confetti thorwn outside windows at a parade.