The Federal Reserve's Exit Strategy
Although the economy remains fragile, it has recovered from its dire straits and is beginning to grow again. Therefore, the Federal Reserve needs to be thinking about how it will withdraw from its heavy involvement in the financial system. If it does not, more problems could arise in the future. Chief among these are the prospect of high inflation and a double-dip recession. In the video to the right, the President of the St. Louis Federal Reserve Bank addresses these issues.
Indeed, in the past few weeks, we have begun to receive a better idea of how the Federal Reserve's exit strategy will look. In partcular, there are three primary concerns for the Federal Reserve: the lending facilities it created in response to the collapse of the financial system, the asset purchases it made from 2008 to 2009, and future interest rates.
Lending Facilities
The various facilities created by the Federal Reserve in response to the financial crisis were inteneded to maintain liquidity in the turbulent market. Now that the system has largely recovered, or at least reached a reasonable level of stability, there is no longer any need for many of these to continue.
Asset Purchase Programs
The purchasing of asset backed securities by the Federal Reserve from 2008 to 2009 was crucial to achieving market stabilization and preventing further bank failures and economic collapse. However, in doing so, the Federal Reserve created enormous amounts of bank reserves, which could dramatically increase the money supply in the coming years. This could create an environment of hyperinflation and cause the economy to slip back into recession.
Interest Rates
Interest rates are currently at historic lows in the United States. The discount rate, the interest rate charged to commercial banks and other depository institutions on loans they receive from the Federal Reserve, is set at seventy-five basis points (0.75%). The federal funds rate, the interest rate banks charge each other for loans, is within a range of zero to twenty-five basis points (.25%). Both of these rates affect other interest rates in the economy, and are managed by the Federal Reserve in accordance with their economic objectives regarding growth and inflation. With both rates lower than ever before, they have nowhere to go but up in the coming months--it's only an issue of by how much and when.
