Fed puts focus on plan to tighten credit

Federal Reserve Bank Chairman Ben Bernanke speaks at the Captiol Hilton Hotel in Washington, D.C.


Kai Ryssdal: Assuming the streets in Washington, D.C., are clear of snow by then -- and there is another big storm on the way -- Ben Bernanke is scheduled to trudge up Capitol Hill later this week. On the face of it, it's going to be one more round of Congressional testimony from the Fed chairman. But there are some expectation he'll use his public remarks over the next few weeks to start laying the groundwork for what might be the Fed's trickiest bet yet -- getting all that money it plowed into the economy safely out.

From Washington, Marketplace's Nancy Marshall Genzer reports.

NANCY MARSHALL GENZER: When times are tough, the Fed pumps extra money into the banking system. That keeps interest rates low for struggling businesses and consumers. For the past two years, the Fed has been raining money down on the economy.

It's piled up like the snow now covering Washington. Soon, it'll be time to start shoveling.

VINCENT REINHART: The Fed has covered the economy with a deep blanket of reserves. That might have been appropriate for some times but at some point it's going to have to dig that out.

Vincent Reinhart is a former Fed economist now at the American Enterprise Institute. He says the Fed will eventually need to shovel up the excess money it's created. Congress has given the Fed a new tool -- the authority to set the interest rates it pays to banks. The hope is they will park more cash in Fed accounts.

Ken Kuttner teaches economics at Williams College.

KENNETH KUTTNER: The Fed is simply trying to say, hey, instead of keeping the money in your mattress, give it to me, we'll take care of it. And in doing so, there'll be less of it sloshing around in the system.

Now, when there's less available cash, interest rates go up. Loans are harder to get. That cools the economy and prevents inflation. But, wait a minute. Aren't we in the middle of a credit crunch? Why would the Fed want to make loans harder to get now?

Catherine Mann teaches economics at Brandeis. She says Fed Chairman Ben Bernanke is using his testimony before Congress to send investors a signal that he won't let the economy recover too quickly.

CATHERINE MANN: Bernanke wants to make very clear that the Federal Reserve has both the commitment as well as the tools to ensure that inflation does not get out of control.

Now, if banks are parking their excess cash at the Fed instead of loaning it to you, interest rates will go up. Because of that, you'll get a better rate on your savings account. But mortgage rates could go up a bit and businesses could pay more for short-term loans. The economy has to be well on the way to recovery before the Fed puts on the brakes, though. And economists don't expect that to happen until later this year.

In Washington, I'm Nancy Marshall Genzer for Marketplace.

About the author

Nancy Marshall-Genzer is a senior reporter for Marketplace based in Washington, D.C. covering daily news.
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If the Federal Reserve focused only about fighting inflation, as Anon suggests, they would not have lowered interest rates. Also, it might be nice if their mission included full employment, but alas, their own web site (http://www.federalreserve.gov/aboutthefed/mission.htm) speaks of maximum employment along with stable prices and moderate long-term interest rates. In my view, the Fed would best serve our economy's long-term interest by focusing on keeping inflation at bay, not on long-term interest rates.

“When times are tough, the Fed pumps extra money into the banking system. That keeps interest rates low for struggling businesses and consumers. For the past two years, the Fed has been raining money down on the economy.”

The Fed lowered interest rates after the dot com crash to quickly revive the economy. By keeping them low too long it helped create a housing bubble. After that bubble burst Bernanke lowered rates to create an equity bubble and a US dollar carry trade. That was done solely to bailout the TBTF financial corporations not to help consumers or small business. The interest rate and bailout was sold as a way to get credit flowing to help consumers and small business. It hasn’t happened.

Since 1970 and the ascension of monetary policy the Fed has focused on “fighting inflation” to the neglect of its other mandate, full employment.

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