Fed strategies for reining in the money
A summary of Federal Reserve strategies from BusinessWeek’s James Cooper:
"Rate increases will come in conjunction with the Fed's new authority to pay banks interest on their deposits. Manipulating this rate, now set at 0.25%, will make it easier for the Fed to control the main target rate, which could be difficult amid the flood of cash sloshing around. A higher deposit rate gives banks incentive to park their excess funds at the Fed and less incentive to lend them out in the interbank market. In this way, the excess funds actually stay in the system, but their potential to create new money and higher inflation is neutralized.
The real question in all this is the timing, something policymakers are already hotly debating. The doves, who are in no hurry to tighten and are in the majority, point to the enormous slack in the economy, which is putting downward pressure on wages and prices and perpetuating the risk of deflation. The hawks say popular measures of underutilized workers and facilities can give misleading impressions of the amount of slack, as was the case in the 1970s."
"Rate increases will come in conjunction with the Fed's new authority to pay banks interest on their deposits. Manipulating this rate, now set at 0.25%, will make it easier for the Fed to control the main target rate, which could be difficult amid the flood of cash sloshing around. A higher deposit rate gives banks incentive to park their excess funds at the Fed and less incentive to lend them out in the interbank market. In this way, the excess funds actually stay in the system, but their potential to create new money and higher inflation is neutralized.
The real question in all this is the timing, something policymakers are already hotly debating. The doves, who are in no hurry to tighten and are in the majority, point to the enormous slack in the economy, which is putting downward pressure on wages and prices and perpetuating the risk of deflation. The hawks say popular measures of underutilized workers and facilities can give misleading impressions of the amount of slack, as was the case in the 1970s."