On Monday the Federal Reserve put forth the idea of creating a new way to withdraw money from the banking system when the need to tighten money policy presents itself.
Dubbed a term deposit facility, what it will do is allow banks or other financial institutions opportunity to earn interest on loans that are of longer duration to the central bank.
There were no specifics from the Fed on how the interest rates would be determined on these loans, but the idea they could be decided through an auction or a specific type of formula was thrown out by the Federal Reserve. One parameter known for sure at this time is they maturity of the loan wouldn’t be longer than one year, with the majority probably being from one to six months, said the Fed.
Other tools looked at being used in an attempt to keep inflation from getting out of control has been the sales of assets of the banks, along with reverse repurchase agreements.
The Fed has been asserting it has the effectiveness to take the stimulus capital out of the market before the inevitable inflation gets out of control. According to the Fed they will be able to do that before inflationary pressures arise; a highly dubious assertion which is unlikely to be backed up since inflationary pressures in some sectors like food prices are already beginning to rise.
This is part of the frustration the banking industry has been experiencing, where they are pressured by Obama to loan to risky companies in order to create more jobs and help the economy, while at the same time regulators tell them to build up their cash reserves and abstain from taking too many risks which could create more problems. These mixed signals can’t coincide, and so you have to have one or the other, but not both.
Of course if banks respond and start lending, which will put the money out there to be used, the consequences will be inflation surging to very high levels.
This is why the Fed is preparing these various mechanisms in an attempt to manage the amount of money loaned into the market in order to keep inflation low. It’s highly doubtful they’ll be able to do this, no matter what gimmicks they develop to keep the money out of the market.
The Fed knows that once the economy actually starts to recover (which it hasn’t), there will be a flood of money pouring into the market. They will attempt to tighten the money supply so the amount of money going out won’t result in extraordinary inflation. I don’t think they can do it, and Americans will have to endure more pain over the long term because of the misguided actions of the Federal Reserve.
