Bernanke was scheduled to deliver testimony today before the Committee on Financial Services, U.S. House of Representatives. It was cancelled due to snow but the press release is available. Here is much of the planned testimony as it relates to the exit strategy and tools in their warchest. When we have more time to study this, there will be more fuel for the discussion on inflation and deflation. Perhaps we can better describe what the Fed policy implications could be.
The Federal Reserve has a number of tools that will enable it to firm the stance of policy at the appropriate time.
Most importantly, in October 2008 the Congress gave the Federal Reserve statutory authority to pay interest on banks' holdings of reserve balances. By increasing the interest rate on reserves, the Federal Reserve will be able to put significant upward pressure on all short-term interest rates, as banks will not supply short-term funds to the money markets at rates significantly below what they can earn by holding reserves at the Federal Reserve Banks. Actual and prospective increases in short-term interest rates will be reflected in turn in longer-term interest rates and in financial conditions more generally.
The Federal Reserve has also been developing a number of additional tools it will be able to use to reduce the large quantity of reserves held by the banking system. Reducing the quantity of reserves will lower the net supply of funds to the money markets, which will improve the Federal Reserve's control of financial conditions by leading to a tighter relationship between the interest rate on reserves and other short-term interest rates.