WASHINGTON — Top Federal Reserve policymakers insisted Wednesday that the central bank has the tools it needs to withdraw all the liquidity it has injected into financial markets but said action on that front is not yet necessary.
"When the time comes, I am confident the Fed has the tools to reverse the assumed monetary stimulus and exit the policies put in place in reaction to the financial crisis and the recession," Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said in a speech at the University of South Alabama.
"I do not think that time has yet come, and … I think it may well be some time before [a] comprehensive exit need be underway."
Donald Kohn, the vice chairman of the Federal Reserve Board, appeared to echo that sentiment.
"I cannot give you a small list of variables that will trigger an exit," he said during a panel discussion at the Cato Institute. "We have the framework to exit from these policies when we need to do so."
As the financial crisis deepened over the past two years, the Fed increasingly coordinated its actions with other central banks.
Speaking at the same panel, Anthanasios Orphanides, a member of the European Central Bank's governing council, indicated there was little sunlight between the Fed's position and that of its European counterpart. "Talking about this topic does not suggest that now is the appropriate time to exit from unconventional policy measures," he said. "Nonetheless, it is important to communicate that an exit strategy exists."
Exactly how policymakers will know the time is ripe for a pullback remains the subject of great discussion.
Pointing to the lag between a policy decision and its impact on financial markets, Kohn indicated the Fed would begin a withdrawal before the financial sector fully rebounds. Since the onset of the financial crisis in August 2007, the Fed's balance sheet has grown more than two and a half times, to $2.16 trillion last week.
Most of this growth has supported myriad of programs designed to provide financial institutions with liquidity during the credit crunch.The challenge for the Fed now is to slim down to its former self, and financial institutions will probably be central to that process. Kohn said the Fed's ability to pay banks interest on the reserves they hold at the central bank — a power it won from Congress last year — is its most important tool.
As the Fed raises the rate it pays on these reserves, it hopes to create a floor for other short-term rates, including the federal funds rate.
Kohn said the Fed continues to look at other ways to drain excess reserves currently on its balance sheet. Some options under consideration include reverse repurchase agreements involving mortgage-backed securities and allowing banks to hold their reserves in separate accounts at the Fed.
The Fed could also sell some of the securities it holds on its balance sheet, Kohn said. But the central bank is often reluctant to go that route; doing so could, among other consequences, force interest rates higher than the Fed would prefer. One option not on the table, according to Kohn, is increasing the reserve requirement for banks. "I don't think that will get us very far," he said.
But not everyone appears content to wait. In a speech on Tuesday, Richard Fisher, the president of the Dallas Fed, aired his desire for an aggressive return to normal for the Fed. "When it comes time to tighten monetary policy, my colleagues and I will move with an alacrity that, if needed, will be equal in speed and intensity to that with which we pursued monetary accommodation," he said.
