Wednesday, December 23, 2009

Guha: Fed pondders exit strategy

At the heart of the exit sequence debate are five interlocking questions. Should the Fed focus on tightening short-term rates as normal or tightening long-term rates through asset sales?

Assuming the Fed focuses on short-term rates, does it need to reduce the more than $1,000bn excess bank reserves substantially, early in the process and ideally before raising rates?

When it starts raising, should it communicate its policy stance in terms of an interest rate on bank reserves rather than a target for the Fed funds rate as in the past?

chart: FedIf it starts tightening without draining the excess reserves, will it have to move more aggressively than it would otherwise have done? And what is the end destination in terms of the monetary policy regime the Fed wants when the exit is complete?

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