Ending aid programs presents challenge
When the financial system was teetering, Federal Reserve Chairman Ben Bernanke flooded it with trillions of dollars to save the banks and free up credit for consumers and businesses.
Looming in the future is a high-risk challenge for the economy’s rescuer-in-chief: He will have to mop up that money without disrupting a nascent recovery.
And timing is vital. Act too fast, and Bernanke risks choking off lending to businesses and everyday Americans. Wait too long, and he risks setting off crippling inflation.
Assuming he manages to help usher in a sustained recovery, Bernanke, like his predecessors, will eventually face still another challenge: He will be under enormous political pressure to keep interest rates low, even though that could speed inflation.
But the Fed chief will face no task with quite the peril of withdrawing the trillions the Fed has pumped into the financial system in ways that had never been envisioned.
That money helped prop up shaky banks. It also was intended to unlock lending to people and companies, a key component of any recovery but one that so far has had only spotty success.
When to pull back the money is an issue sure to surface as Bernanke, his counterparts in other countries, academics and economists meet over the next couple of days at an annual Fed conference in Jackson Hole, Wyo.
Some analysts think it could take four or five years for the Fed to withdraw the money entirely and shrink a balance sheet that is now about $2 trillion, more than double what it was when the financial crisis struck free credit report without a credit card.
Already, the Fed has taken baby steps.
It has said it will allow one program intended to support money market mutual funds — one that hasn’t even been used — to expire Oct. 30. It’s also reduced the maximum it will lend to banks under two other programs.
But this week the Fed extended a separate program designed to increase lending and help the commercial real estate market. So far, about $40 billion in loans has been extended to investors — a small fraction of the $200 billion made available in the program’s first phase. And Americans still have trouble getting loans.
Congress, the White House and statehouses across America will probably exert intense pressure on the Fed to keep the money flowing and the emergency aid programs operating.
Keeping the easy money in place too long could feed high inflation by encouraging overborrowing and overspending. Surging inflation could then derail a recovery if the Fed aggressively boosts interest rates.
But pulling the plug too soon on the Fed’s emergency aid could set back a recovery even faster. If, for instance, the Fed dumped its mortgage securities and interest rates shot up, homeowners and the housing industry would take a further pounding.
To prevent inflation from surging, many economists also think the Fed will have to start raising its key bank lending rate next summer.