Fed to Outline His Wizardry

Posted by Jason | Posted in Economics | Posted on 08-02-2010

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The Wall Street Journal has an article talking about how Ben Bernanke is going to layout his master plan on how to prevent inflation after printing trillions of dollars while at the same time not collapsing the economy. Sounds like a tight rope walk on an icy rope to me.

Federal Reserve Chairman Ben Bernanke will begin this week to lay out a blueprint for a credit tightening, to be followed once the Fed decides the economy has recovered sufficiently.

The centerpiece will be a new tool Congress gave the central bank in October 2008: 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 Fed is still at least several months away from raising interest rates or beginning to drain the flood of money it poured into the financial system in 2008 and 2009. But looking ahead to when the economy is strong enough to warrant tightening credit, officials have been discussing for months which financial levers to pull, when to start and how best to communicate their intent.

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.

In response to the worst financial crisis in decades, the Fed took extraordinary action to prevent an even deeper recession— pushing short-term interest rates to zero and printing trillions of dollars to lower long-term rates. 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.

Couple questions, because I am not an economist. First, where does the money come from to pay this “interest on excess reserves”? I guess they just print it. So the answer to preventing inflation is to print money and pay banks with newly printed money to hold their reserves with the Fed. If what I understand of inflation is correct, it’s the printing of new money that is inflation, and higher prices is just a symptom of inflation. It sounds to me like all this does is create more inflation. Again, I’m not an economist, so I could be completely wrong on this. It sounds to me like someone taking ibuprofen when they have strep throat. You may have minimized the symptoms, but you still have strep throat that needs to be dealt with. (I had strep a month ago, so this was the best example I could think of.)

Second question is is it me or are the conspiracy of bankers controlling the world sounding more and more realistic. They screw up the whole country, and what is their punishment? They get bailouts dollar for dollar with no losses on their bad bets. Then they get paids to keep their share of newly printed money at the Fed. They get paid when they lend it out at 10 to 1, and if they screw up, guess who’s back to bailing them out.

Third question is more rhetorical. Based on the last paragraph, does anyone have “confidence in it’s ability to steer the economy”? This is the same Fed that steered the economy into its current crisis. They created a huge bubble because of their low interest rates, which they are now trying to cure with even lower interest rates. Now they tell us they have a master plan to get us out of printing trillions of dollars without massive inflation.

The nature of its exit from today’s unusually low interest rates will affect everything from mortgage rates and what companies pay on short-term borrowings to the rates savers earn. The timing and sequence of the steps are the subject of intense speculation in financial markets.

You have to just love the government. They blame the speculators when things aren’t going the way they claim they are supposed to go, and then they create all these areas of speculation. If the government would just let the free market work, speculators wouldn’t be sitting around trying to figure out what the government is going to do. I’m sure there are some out there who would pay good money to know before hand what they are going to do. Nah, that would never happen with our “trusted” officials.

Officials are warning investors and banks to prepare for surprises.

In January, Fed Vice Chairman Donald Kohn said: “Interest rates are difficult to forecast in the most settled or normal times, and their path is especially uncertain in the current circumstances.”

The Fed is contemplating other innovative steps to manage some of the money it has pumped in, steps that officials say could come either slightly before or alongside a boost in the rate on reserves.

One is to encourage banks to tie up money at the Fed for a set period—preventing them from lending it—in what are called “term deposits.” Another is to lock up funds, and thus constrain the supply of credit in short-term lending markets, by borrowing against the Fed’s large portfolio of securities holdings, in trades known as “reverse repos.” When the Fed borrows from the markets, it effectively takes money out of circulation and replaces it with securities from its holdings.

via Fed to Outline Future Tightening Steps – WSJ.com.

Oh boy. The Fed is coming up with new tools. What’s the old saying, “when the only tool you have is a hammer, everything looks like a nail”. Sounds to me like they just got different hammers, and they are going to pound the same nail. The problem is we are the ones holding the nails, and I have a feeling we’re going to get our fingers smashed.

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