"Fed Exit Fears Overstated, S&P Economist Says"

From Real Time Economics:

Worries that the Federal Reserve’s attempt to unwind extraordinary monetary support for the U.S. economy will go awry — because the central bank is in uncharted territory — are excessively alarmist, Standard & Poor’s chief global economist Paul Sheard says in a new report.

The Fed has kept official borrowing costs near zero since December 2008, and bought more than $3 trillion in mortgage and Treasury bonds in an effort to jump-start the weakest economic recovery in decades. Growth has been sustained but soft, and the bond purchases have remained controversial. Unemployment has come down from a crisis peak of 10% to 6.2%, but remains elevated for historical standards.

Some economists, including a vocal minority of top Fed officials, fear the large amount of excess reserves in the banking system created by the bond purchases could spark inflation more quickly than in the past. This could complicate the process of increasing rates, critics of the program say, and potentially raise the costs of a policy error.

But Mr. Sheard offers a much more sanguine view.

“As the U.S. Federal Reserve continues its stated process of reducing the amount of its monthly bond purchases, the warnings about impending disaster are growing ever louder,” he writes. “They create the impression among the wider public, and particularly among investors, that central banks have blithely paddled into treacherous waters from which they have no realistic hope of escape.”

Yet that’s simply not the case, Mr. Sheard argues. Instead, the Fed’s unconventional steps were well-advised considering the deep economic malaise facing the country, he says. And despite the relatively untested nature of bond buys, Fed policy makers have already shown they have plenty of tools to withdraw liquidity from the financial system when the time comes....MORE