Fed Expected to Separate Monetary and Liquidity Policy

As the US Federal Reserve wraps up its December two-day interest meeting, it is widely expected that the Fed will hold the line on current interest rates. There is a possibility however, that the Fed will opt to increase rates for the Discount Window which it uses to provide emergency funding to banks and other financial institutions. We could even hear of plans to shut down other forms of emergency liquidity lending as early as February 1st.

While these moves would lead to a tightening of liquidity within the system, this should not be confused with a change to monetary policy. The elimination of liquidity programs – born originally out of the need to address the credit crunch that threatened to topple the world’s largest banks over the past two years – speaks to the depth of recovery that now makes these axillary programs no longer necessary.

Monetary policy on the other hand, remains unaffected. Earlier this year, Federal Reserve Chair Ben Bernanke committed the Fed to holding interest rates at “exceptionally low levels” for an “extended” period of time. It is unlikely that anything will come from the current FOMC meeting to suggest a change to Bernanke’s pledge.

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