Philadelphia Federal Reserve Bank president Charles Plosser this week said he sees no near-term inflation threat, but warned the large volume of excess reserves created by the Fed as a result of its quantitative easing policy could become inflationary if those reserves start flowing rapidly into the economy.
In that event, Plosser said, the Fed would need to act “pretty quickly” to head off an inflation problem — either by raising interest rates or by draining reserves.
Like others, Plosser indicated a preference for raising the rate of interest the Fed pays on reserves — and in turn the federal funds rate — to give financial institutions an incentive to keep their reserves at the Fed instead of lending them.
But he suggested the central bank cannot necessarily rely on that new and not thoroughly tested tool and needs to have a “Plan B.”
That Plan B would include selling assets outright, thereby reducing reserves, or by doing reverse repurchase agreements, which would also drain reserves and could reduce them more or less permanently if the reverse repos were to be continuously rolled over through the maturity of the underlying security.
— Market News International