Fed nearing completion of exit strategy, concerned over risks posed by new tools

JACKSON, Wyoming July 11 Fri Jul 11, 2014 6:08pm EDT

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JACKSON, Wyoming July 11 (Reuters) - The U.S. Federal Reserve has nearly completed development of a new plan for returning to a more normal monetary policy, even as officials remain concerned some of their newest policy tools could pose unintended risks to the financial system, two Fed officials said on Friday.

"We are making very good progress," on the mix of policies that will be used to manage interest rates in the future, Chicago Federal Reserve Bank President Charles Evans said on the sidelines of an economic conference here.

More analysis still needs to be done, and Evans said in particular Fed officials worry their new reverse repo tool could exacerbate any future financial crisis. By in essence accepting short term loans from a broad set of financial institutions, there is concern that banks, money market funds and other large investors could use those repo loans as a massive safe haven in a crisis, pulling money out of circulation and making the crisis worse.

"During a period of quick risk aversion ... we would have to understand what movements into this product would be," Evans said.

Still, he and Atlanta Fed President Dennis Lockhart affirmed what was indicated in the most recent minutes of the Fed's policymaking committee: that the central bank is near completion of one of the core debates needed to set up a post-crisis monetary policy.

Lockhart said he thought a completed policy could be formally announced as early as this fall. He said a main tool will be the interest the Fed pays banks on excess reserves, which could quickly encourage or discourage banks from leaving money on deposit at the Fed, with the reverse repo playing a "supporting role."

The Federal Funds rate, which is the amount banks charge each other for overnight loans, will remain part of the central bank's toolkit. But it is not expected to play the main role it has in the past because reserve-rich banks don't rely on that market as much as they used to.

(Reporting By Howard Schneider; Editing by Meredith Mazzilli)

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