NEW YORK – While the Federal Reserve has been laying the groundwork to allow it to raise interest rates when appropriate, the termination of special liquidity facilities “need not be followed in short order by the initiation of tightening measures,” Federal Reserve Board Governor Daniel K. Tarullo told community bankers in New York today.
Recently, the Fed has “successfully tested our capacity to carry out reverse repo transactions and are expanding the group of counterparties with which these transactions can be carried out. We have also been working on the development of a term deposit facility. These analytic and practical steps are obviously taking place in preparation for a change in monetary policy. But it is important to emphasize that the completion of preparatory steps need not be followed in short order by the initiation of tightening measures,” Tarullo said according to prepared text of his remarks, which was released by the Fed. “The preparations for exit will allow us to move with confidence when the time is right. They do not push us toward the door. Indeed, the relatively modest pace of recovery, the continued high rate of unemployment, subdued inflation trends, and well-anchored inflation expectations together suggest that the need for highly accommodative monetary policies will not diminish soon. Of course, we should and will be attentive to new information suggesting otherwise.”
In effect, he said, it is not a single exit strategy, because ending the special liquidity facilities will help “normalize” Fed activities “as liquidity provider of last resort when the exceptional stresses have eased sufficiently,” while the second part of the strategy is raising interest rates “when warranted by economic conditions,” he said. With “an unusually high level of reserves” in the banking system, “the Fed cannot simply raise its target for the federal funds rate; it will have to take other steps to ensure that interest rates actually increase.”
With the termination of the special facilities, Tarullo said, “the first objective has now been substantially achieved.” However, “unlike a monetary policy action under more normal conditions, our eventual decision to raise interest rates will require a determination of the mix and sequencing of these policy tools, as well as the basic determination of when monetary tightening is appropriate.”
