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Tuesday, May 20, 2014 3:54 PM


Debate Over Fed's Exit Strategy Continues: Bernanke vs. Dudley vs. Yellen


Yesterday, former fed chair Ben Bernanke said "No Need for Fed to Shrink Balance Sheet".

The Federal Reserve does not need to shrink its $4 trillion-plus balance sheet by even "a dime" for it to normalize monetary policy when the time comes, former Fed Chair Ben Bernanke said on Monday.

"The Fed has worked very carefully to figure out how to raise rates at the appropriate time," Bernanke told a monetary policy conference. "That will eventually happen - we hope it happens because that means the economy is going back to normal."

When the Fed does tighten, he said, "you can have some bumpiness" as markets potentially react to the changes. But in all, he said, "it will be a fairly normal process."
Bernanke 2010 Flashback

In 2010, Bernanke told Congress Fed is Receptive to Selling Security Holdings.
The Federal Reserve is open to selling some of the securities now on its books as part of its withdrawal from its unconventional efforts to prop up the economy, Chairman Ben S. Bernanke said Thursday, in a change of tone on how the Fed will execute its exit strategy from crisis-era interventions.

 Bernanke, testifying Thursday before the House Financial Services Committee, said that "if necessary," the Fed "has the option of redeeming or selling securities" bought during the crisis. In written testimony to the same committee on Feb. 10, he was more ambiguous, stating that he did not "anticipate that the Federal Reserve will sell any of its security holdings in the near term," at least until after the Fed had begun raising interest rates and the economy had clearly begun a sustainable recovery.

Similarly, Bernanke said Thursday that "restoring the size and composition of the balance sheet to a more normal configuration is a longer-term objective of our policies."
Dudley Proposes Exit Change Strategy

Today, the Financial Times reports NY Fed President Floats Change to Exit Strategy
One of the US Federal Reserve’s most influential officials has called for a change to its exit strategy from easy monetary policy.

William Dudley, president of the New York Fed, said the central bank should keep reinvesting in its mortgage portfolio until after it raises interest rates. The current exit strategy calls for stopping reinvestment before rates go up.

The call for the Fed to keep its mortgage portfolio larger for longer signals how exit strategy is now the most active policy debate at the central bank as the US economy gets closer to full employment. The possibility of more sustained Fed demand may boost markets for mortgage-backed securities.

Mr Dudley said that raising interest rates would give the Fed the flexibility to cut them again if the economy gets into trouble, so it is more important than reducing the MBS portfolio.

"Delaying the end of reinvestment puts the emphasis where it needs to be – getting off the zero lower bound for interest rates," said Mr Dudley in a speech to the New York Association for Business Economics on Tuesday.

"In my opinion, this is far more important than the consequences of the balance sheet being a little larger for a little longer."
In the near-term, Janet Yellen is the chair and she will get her way.

Dudley's idea of hiking now so there is room to lower rates later is not going to happen. Bernanke is out of the picture.

If housing continues to crumble with employment reasonable, perhaps the Fed tapers at the existing pace, with all or most of the tapering in treasuries, with little or no tapering in mortgage-backed-securities. To appease Dudley, a change of that nature is a reasonable bet.

Mid-term, if employment growth stalls, tapering will slow or halt.

Long-term, hikes are longer off than most realize. Also, the Fed will never sell anything. Assets will be held to term.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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