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Fed Plotting Strategy to Raise Interest Rates

Monday, 08 Feb 2010 04:54 PM

The Federal Reserve is prepping ways to raise interest rates and take other measures to drain the money it pumped into the financial system in an attempt to prop up the economy.

While the Fed is still a couple of months away from taking concrete action, the central bank is currently deciding which buttons to push to keep the economy in control, according to the Wall Street Journal.

One such measure to mop up liquidity from the system includes raising the rates paid on excess reserves, according to Fed officials in interviews and recent speeches.

The Fed expects such a maneuver to boost other key short-term rates, including the federal-funds rate at which banks lend to each other overnight, the Journal reports.

“If the (Fed) were to raise the interest rate paid on excess reserves, this would raise the price of credit,” says New York Fed President William Dudley, according to the Journal.

“That, in turn, would limit the demand for credit.”

The Federal Reserve has lowered interest rates and printed money with the aim of getting the economy out of the worst recession since the 1930s.

Economists are watching the Fed to see how it can yank such stimulus measures out of the economy, with some saying that pulling out too soon means sending the country back into a recession with others saying pulling out too late will fuel inflation.

In the past, the Federal Reserve could hike its target for the federal-funds rate to steer the country away from inflation.

But since the U.S. central bank has pumped so much money into the economy, such a measure must be accompanied by other moves to control the economy.

Monetary authorities, the Journal reports, want to buy up to $1.25 trillion in mortgage-backed securities to hold down mortgage rates and buoy housing.

Over time, Fed officials want to reduce those holdings and return to holding U.S. Treasury securities as a primary asset, but officials don't want to rush and take steps that might push mortgage rates higher and damage the fragile housing market.

Eventually, the Fed could gradually sell mortgage securities, but such a move would be unlikely in the early stages of tightening, the Journal reports.

A senior Federal Reserve official has said the central bank may sell assets to trim its bloated balance sheet.

Last year, the Fed's purchases of longer-term Treasuries and other debt, undertaken to help revive the economy, were financed by adding cash to the financial system, a move that fueled risks of inflation.

“Maybe you get in the second half of 2010 or something like that, if things are going pretty well, maybe then you'd sell a little bit at that point and you'd try to see how the market reacts,” St. Louis Federal Reserve Bank President James Bullard tells Reuters.

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The Federal Reserve is prepping ways to raise interest rates and take other measures to drain the money it pumped into the financial system in an attempt to prop up the economy. While the Fed is still a couple of months away from taking concrete action, the central bank is...
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2010-54-08
Monday, 08 Feb 2010 04:54 PM
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