Fed Chairman Bernanke yesterday provided more clarity about the Fed’s exit strategy from the current accommodative policy stance. In fact, he outlined a possible sequence:
- Test its tools for draining reserves, which include reverse repos and term deposits. For the former, he said the Fed is in the process of expanding its counterparties and developing means to use MBS as collateral. On term deposits, Bernanke said that he expects to begin tests this spring and have the facility available “if necessary shortly after.”
- “Scale up” draining operations to drain more “significant volumes of reserves to provide control over short-term interest rates.”
- Hike the interest paid on excess reserves rate (IOER). Bernanke said that if the Fed deems it appropriate to exit more rapidly, it could chose to hike the IOER at the same time it engages in significant reserve draining (step #2).
The sequence Bernanke outlined is consistent with forecasts that the Fed will begin large-scale reserve draining in midsummer followed by interest rate hikes in September. While Bernanke provided more detail on the exit process, he did not provide much more insight into the timing. Indeed, he reiterated that the Fed expects conditions to warrant exceptionally low levels of the fed funds rate for an extended period.
