U.S. Federal Reserve Chairman Ben S. Bernanke said yesterday (Tuesday) that the worst recession since the Great Depression is "very likely over." However, Bernanke also said that unemployment would remain high and keep the recovery from accelerating.
"Even though, from a technical perspective, the recession is very likely over at this point," Bernanke said, "it's still going to feel like a very weak economy for some time, as many people still find that their job security and their employment status is not what they wish it was. So that is a challenge for us and all policy-makers going forward."
The real challenge for Fed policymakers will be to gingerly dismantle all of the programs they set in place to backstop the markets - such as the Commercial Paper Funding Facility - which holds $109.2 billion in short-term IOUs issued by corporations - and the Term Asset-Backed Securities Loan Facility (TALF) - which has lent $25 billion to investors to buy securities tied to auto and other consumer and business loans.
In all, Bernanke has injected more than $2 trillion into the U.S. financial system. He's also lowered the Federal Reserve's benchmark lending rate to a record low range of 0.00%- 0.25%.
Earlier this month, Bernanke said that the central bank's program to buy U.S. Treasury securities would be shut down by the end of October. He's also pointed out that some of the Fed's emergency lending facilities automatically wind down as the economy recovers, because they have onerous pricing and terms.
The central bank could undertake two key steps to accelerate that whole process. It could:
- Increase the amount of interest paid on balances held at the Federal Reserve by depository institutions (banks).
- Sell securities from the Federal Reserve's portfolio with the agreement to buy them back at a later date.
However, Bernanke has provided very few clues about what his so-called "exit strategy" will involve, or how it will be implemented. That is, at what point will inflation become enough of a concern, and at what point does U.S. growth become sustainable enough, to warrant a change in Fed policy?
At some point, Bernanke will have to raise the Fed's benchmark rate from its current record low range. However, doing so to soon could undermine the fragile recovery, while waiting too long could lead to a surge in inflation.
The Federal Open Market Committee (FOMC) voted unanimously to keep the benchmark Federal Funds Rate at its at its record low range. But as the economy recovers, there is likely to be more disagreement over whether or not the withdrawal of monetary stimulus is moving at the appropriate pace.
"In my career, I have never witnessed a situation like the one that exists now, when views about inflation risks have coalesced into two diametrically opposed camps," said San Francisco Federal Reserve Bank President Janet Yellen. "My personal belief is that the more significant threat to price stability over the next several years stems from the disinflationary forces unleashed by the enormous slack in the economy."
Yellen, like Bernanke, acknowledged that an economic recovery appears to be underway, but said that it will "remain vulnerable." Unemployment will remain high, she said, and "threatens to push inflation lower."
Still, Yellen was steadfast in her assertion that the Federal Reserve will keep a close eye on inflationary pressures.
"We at the Fed are ready, willing, and able to tighten policy when it's necessary to maintain price stability, " she said. "We don't want to wait until we're at 5% unemployment and 2% inflation because if we wait that long, given the lags in monetary policy, we'd clearly overshoot."
News and Related Story Links:
- Money Morning:
With Reappointment in the Bag, Fed Chairman Ben Bernanke Turns to Face Troublesome New Challenges
- Money Morning:
Exit Strategy Category