Bailout Repayments Will Affect Interest Rate Policy
The Federal Reserve is probably one of the most criticized (semi-)Federal institutions right now. From the constant grilling of Ben Bernanke as he testifies before the House Financial Services Subcommittee to the bill, HR 1207, that would audit the Fed, the Fed is certainly in the middle of all kinds of macroeconomic discussion.
Interest Rate Criticism
One of the most obvious, and arguably the most deserving, discussion point for the Federal Reserve is interest rate policy. The Federal Reserve, as we all know, has lowered interest rates to a record low in order to inflate the money supply while making credit less expensive, making expansion more affordable. Though many are calling for the Fed to raise rates, its unlikely they will for a completely unrelated reason.
The bailout was conducted as a matter of fiscal policy. The United States borrowed $700 billion from creditors via treasury auctions which it then lent/traded for stock in various financial institutions through the Troubled Asset Relief Program. This money was meant to 1) remove bad assets from banks 2) increase a deflating money supply and 3) make credit more accessible. Since most of the loans were completed at a high interest rate (as if the recipients were even creditworthy), many banks are already moving to pay the loans back. Bank of America is planning to repay $19 billion, while AIG is repaying another $20 billion and many other smaller banks are making smaller contributions.
Why it affects interest rate policy
To create low rates the Federal Reserve must expand the money supply so that there is enough credit to bid down the overnight rate to meet its objectives. When the money from TARP is repaid, it will flow back to the treasury where it will then be used to write off the debt the US government incurred. This decreases the money supply as debt that increased the money supply is neutralized and interest payments remove even more than was originally added.
There are very few people calling for the Fed to keep rates as low as they are right now. Even fewer are advocating lower rates and the majority are calling for an increase in the overnight rate. With Ben Bernanke up for a second appointment and the money supply decreasing by process of TARP repayments, Bernanke has to keep his cool while pushing off concerns of inflation. My guess is that interest rates stick until another quarter of strong GDP growth. And even then, we’ll be lucky if we get 10 basis points.