Tuesday, January 13, 2009

The exit plan of Ben Bernanke

Here is the speech Ben gave at LSE today.

Ben first explained his approach in dealing with the financial crisis with the asset side of the Fed's balance sheet. Jim Hamilton does not like this approach but Ben clearly laid out his exit strategy focusing on how he will manage the inflation expectation as the economy recovers. He is building the expectation or say anchoring it by doing exactly what he is doing now: talking about it. It sounds like Ben knows what he is doing. But I am with Jim that the Fed probably should minimize the interest paid to excess reserve since paying interest on reserve itself is a contractionary policy and on the other hand, the Fed is trying to create liquidity in credit market, which is monetary expansion. I think maybe the Fed can sell something like the loan insurance to the banks, which may be helpful.

A little puzzle raised by Hamilton is that the Fed hope that by removing the toxic assets from the banks' balance sheet, the banks will start to lend out money again. However, the goal is not fully achieved for a while, at least. On the other hand, had the Fed not removed those toxic assets from the banks' balance sheet, there will be no credit easing for sure. Hamilton suggested that the Fed should off-load the colorful assets it has taken onto the asset side of its balance sheet, but my question is: How? Who will buy them and at what price? Won't that result in an immediate loss? It seems that the Fed need to do something effective in boost long-term lending for now and worry about everything else later since if the economy goes deeper into recession, the loss for taxpayers will be even higher.

Here is Q&A session.

Here is Hamilton's response.

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