In testimony before the House Financial Services Committee, Bernanke said that the outlook for monetary policy has not changed since the FOMC January meeting, and reiterated that low rates are warranted “for an extended period.” Bernanke said “”the economy continues to require the support of accommodative monetary policies. However, we have been working to ensure that we have the tools to reverse, at the appropriate time, the currently very high degree of monetary stimulus.”

Fed Targets Discount Rate

One of the first steps the Fed is likely to take will be to boost the interest rate it pays banks on money they leave at the central bank. Bumping up that rate, now at 0.25%, would give banks an incentive to keep money parked at the Fed, rather than lend it and would work to raise commercial banks’ prime rate, increasing the cost to borrow. This means that the Fed will rely less on the usual tool it uses to try and influence the economy – the federal funds rate. The federal funds rate is currently in a range of 0% to 0.25%. The ability to change the interest paid on money parked at the Fed is a relatively new tool, authorized in 2006, though many foreign central banks rely on it.

Also, the Fed is likely to bump up the rate it charges banks for emergency loans, called the discount rate, which is currently at 0.50%. “Before long, we expect to consider a modest increase in the spread between the discount rate and the target federal funds rate” Bernanke said.

The changes to the discount rate “are not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signaling any change in the outlook for monetary policy, which remains about as it was at the time of the January meeting of the FOMC,” Bernanke said.

However these steps will be taken when the economy is on better footing. “Although at present the U.S. economy continues to require the support of highly accommodative monetary policies, at some point the Federal Reserve will need to tighten financial conditions by raising short-term interest rates and reducing the quantity of bank reserves outstanding,” Bernanke said.

Provided by: Federal Reserve
Official Release: Testimony

Greenback Extends Gains

Bernanke’s comments helped the Dollar to extend gains versus the Euro and reversed a loss against the Japanese Yen on the signal that the Fed may raise its discount rate before the more closely watched federal funds rate. Also, his comments worked to flatted the Treasury yield curve, as investors sold short-dated Treasurys, narrowing the yield between the two-year and the 10-year maturities.