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  • How and When to exit Mr Bernanke?

    Posted on January 25th, 2010 Peter Tjernström No comments

    bernankeIndependent of whether the Feds Chairman will receive his confirmation vote for a second term in office or not, the Fed will have to think about how it should eventually exit from unconventional monetary policy. Story in short: Since August 2008 the Fed balance sheet has increased from $874bn to $2,190bn, with most of the increase financed by creating bank reserve. The Fed has in total accumulated assets for more than $1000bn and at the same time interest rates have been slashed to almost zero. Other central banks (e.g. the Swedish Riksbank) have taken a different route to improving liquidity and issued short-term loans with very low, fixed, interest rate. In this case the exit will take care of itself; the loans will mature (in most cases after one year) and as long as no further loans are issued things will return to normal. Not so for Mr Bernanke, who has to think about if he should tighten policy by selling back Fed’s assets before increasing the interest rate in order to curb inflation and prevent the formation of excess bubbles.

    When contemplating these $1000bn and the low interest rate, it is easy to see that demand is manipulated and that the stock market has been on steroids for the last 10 months. Owning shares right now feels a bit like being in a chicken race. When all the fiscal stimulus around the world is being pulled back from the markets, share prices are going to be shaky for some time. If this exit isn’t handled with extra care, it can also severely hurt real demand in the economy and pull some countries back into a recession. But this is actually a good reason for staying in the chicken race for some time. Who wants to end the stimulus sooner rather than later if the stakes are so high? If you move slowly and save the world economy, who cares if you create a few asset bubbles along the way?

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