During this gratuitous recession, the worst felt since the 1930s, the Federal Reserve (the Fed) has played an integral role in reviving the economy. The Fed is the only entity capable of quickly enacting the broad policies needed to promote lending during tight-money times to stabilize the economy. Starting October 2008 after the financial markets ceased functioning, the Fed infused large amounts of money into the banking system to ensure funds were available to banks to re-lend to borrowers for all types of lending, such as purchase-assist loans. In this healing endeavor, the Fed’s balance sheet (lending) has grown to $2 trillion, more than double its size before the financial crisis took hold.

The Fed’s stimulative actions have been largely successful and the worst case scenario, total collapse of the financial industry, has been avoided. However, as is always the case whenever the Fed introduces large amounts of money into circulation, inflationary fears strike many. If the Fed siphons out the money too quickly to appease those fears, the burgeoning recovery could die, but if it is taken out too late, inflation pessimists fear devastating inflation will inevitably ensue.

Fortunately, the Fed is well aware of these inflationary risks and has already begun testing tools to prudently remove the money from circulation. Under a new tool, the Fed sells securities from its portfolio under the agreement to buy them back in the future, an arrangement called reverse repurchase. The securities will be sold to a large set of investors beyond just the traditional securities dealers such as Banc of America Securities.

Though the reverse repurchase arrangement tool is only in the testing stage, when the time comes to suck the money back out before inflationary patterns emerge, the Fed will be ready, well practiced and poised.

first tuesday take: It is important to remember that what the Fed puts in, the Fed can just as efficiently pull back out. It has been the fundamental purpose of the Fed for the past 100 years to perform corrective actions such as these, and it is the Fed’s innate duty to monitor and control inflation. These inflation pessimists are blinded by a foregone inflationary conclusion and are ignorant of the Fed’s primary function, duty and ability. [For more information regarding the recent inflation paranoia, see the October 2009 first tuesday article, Fear mongers’ inflation prediction unjustifiable.]

Re: “Fed tests tool for reeling in money from economy,” from the USA Today.

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