The Federal Reserve Bank of New York said Monday it is "testing" reverse repurchase agreements as it studies a tool the central bank could use to sop up excess cash.
Since the beginning of the financial crisis, the Fed has made a point of flooding markets with money in an effort to revive credit markets. With tentative signs of improvement in those markets, the Fed is now faced with the challenge of withdrawing much of that liquidity before it leads to inflation.
By selling securities into the market though the repurchase agreements, much of that liquidity could be drained. But the New York Fed was clear in its statement that it has not actually begun the repurchases and said its communication should not be interpreted as the beginning of the central bank's exit strategy.
"This work is a matter of prudent advance planning by the Federal Reserve, and no inference should be drawn about the timing of monetary policy tightening," according to the statement.
The New York Fed's last repurchase transaction was in December 2008. The central bank typically makes these deals through its network of primary dealers - the roughly 20 firms that buy and sell securities with the Fed - but said it could go beyond that group.
"The Federal Reserve continues to study this issue, and no decisions have been made regarding the types of firms that may be included," the New York Fed said.
Fed officials have also floated the idea of allowing banks to hold their reserves in separate accounts at the central bank.
Monday's announcement came at the onset of a week full of speeches from top Fed officials, including Chairman Ben Bernanke and Vice Chairman Donald Kohn.