The Fed’s exit strategy

by on August 12, 2009 at 2:51 am in Economics | Permalink

This FT discussion is from former Federal Reserve Governor Randall Kroszner, who is now back at the University of Chicago.  Here is the closing bit:

Turning back to today, countries have committed to massive increases in
fiscal expenditure (see chart 4), much of which is not going to be
spent until 2010 or 2011. As economies begin to stabilise and grow,
central banks will face a dilemma – is growth part of a sustainable
recovery or due to a short-term impact of fiscal stimulus? If the
former, then it is sensible to implement exit strategies from unusual
accommodation; if not, then it might be appropriate to wait to see
whether growth has taken root, which entails greater risks of
inflation. Separating the impact of fiscal stimulus from sustainable
economic growth to determine the time to begin to “exit” will be a key
challenge for central banks during the next few years.

Read the whole thing; it also has a useful discussion of how interest on reserves plays into the idea of an exit strategy.

anonymous August 12, 2009 at 9:06 am

The hardest part isn’t riding the tiger.

The hardest part is figuring out how to safely dismount and walk away without getting devoured.

Maybe you can’t.

D. Watson August 12, 2009 at 3:44 pm

Of course, there’s Sumner’s comment about the Fed’s exit strategy: Now if only they had an entrance strategy….
(www.blogsandwikis.bentley.edu/themoneyillusion/?p=1927)

Mario Rizzo August 13, 2009 at 12:01 am

It seems to me that about the time the current stimulus begins to wind down the crisis of Medicare begins. Now if you think the latter can be averted by reforms we might see a decline in deficits. Fat chance. I think the fiscal disaster will make Fed exit either politically impossible or quite nasty.

bob pozen August 14, 2009 at 2:29 pm

Dear Tyler, this is an excellent article by a professor with real world experience at the Fed. I agree totally that keep the interest rate high on reserves is a way to drain dollars from the financial system as the economy starts to grow and inflation threatens.
But now it seems that we should be keeping interest rates on reserves as low as possible to encourage banks to lend, rather than maintain reserves at the Fed. Of course, it is hard to keep interest rates on reserves lower than the policy rate now because the policy rate is so low. But when the policy rate was 1%,
the Fed did not keep its rate on reserves at one quarter of 1%. In fact, the Fed appears to have increased its rate on reserves to get closer to its policy rate. Can you explain the Fed’s rationale in following this strategy? thanks, bob

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