Low inflation and a sluggish economy are "likely to warrant exceptionally low levels of the federal funds rate for an extended period," Federal Reserve Chairman Ben S. Bernanke told the House Banking Committee today.
He said the Fed will have to take steps to tighten monetary conditions and avoid inflation "in due course," but didn't outline a timetable.
Bernanke promised that when those events happen, one of the areas in which the Fed takes action will be to raise interest rates on bank deposits at the Fed. This will put "significant upward pressure on all short-term interest rates," he predicted.
Last week the Fed's Open Market Committee voted 9-1 to keep the target funds rate-the one banks use when lending to each other-at 0% to 0.25%.
He told lawmakers that the Fed has begun scaling back some of the investments that it made-such as the purchase of mortgage-backed securities-during the recession.
Bernanke also said that the Fed is working on ways to reduce the large quantity of reserves held by the banking system, which will result in a closer correlation between the interest rate paid on reserves and other interest rates. One such tool to accomplish this will be to offer depository institutions term deposits at the Fed.