US to raise rate, drain reserves

Federal Reserve Chairman Ben Bernanke said Sunday the U.S. central bank has a robust strategy to exit from the extraordinary stimulus it made to counter the worst recession in decades.

In response to questions at a meeting of the American Economic Association, Bernanke said the strategy “includes both raising the interest rate that we pay on reserves, plus a number of measures that we have been testing that will allow us to drain reserves from the system.”

The Fed last week proposed selling interest-bearing term deposits to banks, a move that would help drain the extraordinary amount of money pumped into the economy once the central bank decides to tighten policy.

The Fed is also testing another tool, reverse repurchase agreements, in which the central bank sells securities from its portfolio with an agreement to buy them back later. Under the arrangement, the buyers move cash from banks to the Fed, removing reserves from the system.

Bernanke’s remarks came right after Fed Vice Chairman Donald Kohn said the central bank will need to be ahead of the curve in withdrawing stimulus as the economy gradually improves.

Kohn also cited the Fed’s ability to pay interest rates on bank reserves, along with temporary actions the Fed can use to move securities off its balance sheet as key tools.

Turning to other issues, Bernanke said the U.S. dollar remains the world’s dominant reserve currency and that’s why it strengthens when economic conditions become more worrisome.

“People still view the U.S. dollar as a safe haven currency and U.S. markets as being the deepest and most liquid markets in the world,” Bernanke said.

After weakening considerably in 2009, the dollar rallied at the end of last year on expectations the Fed may begin to raise interest rates from their current record lows, meaning the currency will yield investors more.