Beckner is a veteran and well respected Fed Watcher. Some one was kind enough to forward to me his latest epistle. Here it is in its entirety:
The Beckner Report: Fed Designing, Not Opening, Exit Door Nov 13 /
FED STILL DESIGNING EXIT DOOR, BUT NOT READY TO OPEN IT
By Steven K. Beckner
Friday, Nov. 13, 2009
It’s becoming increasingly clear to me that, when the time comes
for the Federal Reserve to begin the credit tightening process, it is
probably going to feel the need, at least in the early going, to do some
combination of reserve draining and hikes in the federal funds rate,
supported by increases in the interest it pays on excess reserves.
There just is not enough confidence in the ability of interest on
reserves to set a floor under the funds rate for the Fed to rely solely
on that tool initially.
As Philadelphia Federal Reserve Bank President Charles Plosser told
me, the Fed is going to need a “Plan B.” And I’ve heard similar comments
It is equally clear to me that, notwithstanding all the talk about
“exit strategy,” the Fed is nowhere near actually using any of its exit
In announcing recently that it plans to test reverse repurchase
agreements in tri-party markets, the New York Fed made a point of
cautioning that “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.”
Naturally, that didn’t stop some from talking about early
implementation of an “exit strategy,” but I have good reason to believe
that talk is off base and that the Fed was being sincere.
I can tell you with some assurance that, based on current Fed
assumptions, no such implementation is near at hand. And no decision has
been made about either timing of the exit or the sequence in which the
various tightening tools — raising interest on reserves, selling
assets, doing reverse repos — will be deployed.
There is very little pressure on the Fed to make those kinds of
decisions now. Besides, its choices are going to be determined in good
part by how the recovery unfolds, in particular the behavior of the
housing market. Those are still imponderables.
What kind of exit strategies are being implemented by foreign
monetary authorities could also have a bearing in this brave new world
of international coordination.
Keep in mind that at their Nov. 7 meeting in St. Andrews, Scotland,
Fed Chairman Ben Bernanke, Treasury Secretary Timothy Geithner and their
counterparts from other major industrial nations and key developing
countries jointly declared that, “to restore the global economy and
financial system to health, we agreed to maintain support for the
recovery until it is assured.”
And when it comes time to withdrawal that support, the G-20 pledge
to work closely together.
“While we will continue to provide support for the economy until
the recovery is secured, we also commit to develop further our
strategies for managing the withdrawal from our extraordinary
macroeconomic and financial support measures,” their communique said.
“We agreed to cooperate and coordinate, taking into account any
spillovers caused by our strategies, and consulting and sharing
information where possible.”
It may or may not turn out that way, but this pledge of cooperation
on exit strategy is being taken very seriously at the Fed and elsewhere.
For now though, as I say, the Fed is merely talking about exit
strategy, knowing full well that, despite its statements to the
contrary, its comments in this vein are prompting market speculation
about how soon actual implementation will begin.
I suspect that one reason the Fed is talking so much about its
“tools” is to keep inflation expectations under control by providing
reasssurance that it will be able to tighten credit when the time comes
despite a large and growing balance sheet. Another lesser motive may be
to lend a little indirect rhetorical support to the beleaguered U.S.
The problem, of course, is that eventually the Fed has to start to
back up this kind of talk with action or risk losing credibility. At
some point the Fed will start to sound foolish and unbelievable if it
keeps talking about all the tools it has but keeps them locked away.
In its Nov. 4 announcement that it had decided unanimously to keep
the federal funds rate target between zero and 25 basis points, the
Federal Open Market Committee once again signaled its intention to keep
policy very lax for a long period of time.
The only difference is that this time it was a little more specific
about its reasoning beyond just citing “economic conditions.” It said
the FOMC “continues to anticipate that economic conditions, including
low rates of resource utilization, subdued inflation trends, and stable
inflation expectations, are likely to warrant exceptionally low levels
of the federal funds rate for an extended period.”
Plosser told me that listing of causes for keeping rates low was
“an important effort to be more transparent and more systematic in the
way we approach policy.”
The rest of the statement tended to reinforce the consensus FOMC
view that there is no need to tighten anytime soon. It reflected a
continuing high degree of uncertainty about the economic outlook.
“Information received since the Federal Open Market Committee met
in September suggests that economic activity has continued to pick up,”
it began. “Conditions in financial markets were roughly unchanged, on
balance, over the intermeeting period. Activity in the housing sector
has increased over recent months.” But the statement went on to point to
major impediments to the expansion. “Household spending appears to be
expanding but remains constrained by ongoing job losses, sluggish income
growth, lower housing wealth, and tight credit,” it said. “Businesses
are still cutting back on fixed investment and staffing, though at a
slower pace; they continue to make progress in bringing inventory stocks
into better alignment with sales.”
“Although economic activity is likely to remain weak for a time,
the Committee anticipates that policy actions to stabilize financial
markets and institutions, fiscal and monetary stimulus, and market
forces will support a strengthening of economic growth and a gradual
return to higher levels of resource utilization in a context of price
stability,” the Fed reiterated.
What’s more, the key passage on inflation was unchanged. “With
substantial resource slack likely to continue to dampen cost pressures
and with longer-term inflation expectations stable, the Committee
expects that inflation will remain subdued for some time.”
I have good reason to believe that there was little meaningful
change in a positive direction in the FOMC’s quarterly, three-year
forecast, which will be released in a couple of weeks.
Since the FOMC meeting, an array of officials have spoken publicly
and privately, and the more or less consistent message has been that,
yes, the Fed must eventually normalize rates and shrink the balance
sheet, but that there is no urgency to do so.
Plosser is generally regarded as one of the more hawkish Fed
presidents. So while he is not an FOMC voter this year his comments in
an interview with me a couple days ago are very significant.
Plosser took pains to emphasize more than once that he does not see
any near-term inflation threat, even though he expects unemployment to
peak around the turn of the year and the economy to gain strength next
His biggest concern — one that seems to be shared to one degree or
another around the Fed — is that the massive excess reserves generated
by Fed asset purchases could at some point flow into the economy —
perhaps fairly suddenly — as business and household demand for credit
rekindles and banks become more willing to lend.
“There is $800 billion-$900 billion of excess reserves sitting in
the banking system,” he said. “These are not inflationary at the moment,
because they’re sitting in the banking system.”
However, “were all those excess reserves to start flowing out into
the economy in the form of loans or purchases of other assets … we
could conceivably have a serious inflation problem,” Plosser said, “And
we would have to do something about that.”
“If excess reserves were beginning to flow out into the economy in
a rapid way, which they could — they haven’t yet, but they could — we
would have to act in a way to resist that,” Plosser said. “All the
excess reserves in the banking system that are sitting there right now
are not inflationary, but they could become inflationary if we’re not
So the Fed will be keeping a very close eye on the behavior of
excess reserves and bank credit, among other things.