Most economic observers believe that the U.S. 2007-2009 Great Recession ended sometime between June and August of 2009, and most likely in July of that year. In fact, the U.S. economy experienced real GDP growth of 2.2 percent in the third quarter and 5.7 percent in the fourth quarter of 2009. Global economic growth for 2010 is forecast at 3.3 percent and for emerging economies at 5.6 percent.
Given this relatively high economic growth and increases in prices of commodities and properties, countries like Australia, Canada, Brazil and more recently China are tightening their money supply and raising interest rates. China has tightened by increasing the commercial banks' reserve requirements at the central bank. This can mop up excess reserves and reduce banks’ liquidity and their ability to create loans and deposits. This monetary policy tool has the potential of making banks less liquid.
The U.S.Federal Reserve (Fed) used this tool too soon in 1937 as a pre-emptive strike against inflation. As a result, he United States experienced a recession not long after it emerged from the 1929-1933 Great Depression. But the Fed now has a new monetary tool in its arsenal that didn't have few years ago. In October 2008, the Congress allowed the Fed to pay interest on the commercial banks' required and excess reserves deposited at it. The U.S. central bank can now raise the interest rate on those reserves without making banks less liquid. The banks in return will be willing to keep their excessive reserves at the Fed longer and earn higher return without lending them out in the federal funds and loan markets.  The increase in interest rate on excess reserves should raise other short term interest rates such as the Federal funds and discount rates which equilibrate the supply and demand of bank reserves. This will be the Fed’s first effective move in its “exit strategy”.
The new monetary tool has given the Fed the advantage of using time to move in sequence as it monitors the paces of both economic growth and inflation. If economic growth starts to accelerate and inflation begins to take traction, the Fed can then use its traditional monetary tools such as the reserve requirements and open market operations to increase its federal funds rate.
A first guidepost in monitoring the Fed’s initial action of its exit strategy is the scheduled end of the Fed’s mandate of buying government-backed mortgages-backed securities in March 2010. The Fed has bought those securities to help keep mortgage rates low and encourage Americans to buy houses. This practice has made commercial banks more liquid by increasing their excess reserves. The banks in turn earned interest on those reserves and used the proceeds to lend to the federal government, an action that increased their profitability and bonuses! Speculators have borrowed from the banks at low interest rates, raised commodity prices and engaged in carry trade in the foreign exchange market that has helped reduce the value of the dollar.
Once the Fed ends buying the mortgage backed securities and stops its quantitative easing, it will be in a position to raise the discount rates and the ederal funds . My best guess is that the Fed will be in such position around June 2010 or so. A second guidepost which the Fed can monitor is the behavior of the futures federal funds rate which incorporates the Fed's intentions and actions. In the meantime, the Fed will likely wait to use its traditional tools until sometime later which could be the fall of 2010. But will the Fed be able to time it and balance it without bringing another recession soon? This is a different question and time will answer it.
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