Fed weighs how it will raise interest rates

With the economy and job market picking up, the Federal Reserve is beginning to study how it will raise interest rates even while the financial system is flush with Fed money, according to Fed meeting minutes released Wednesday.

The minutes of the April 29-30 meeting show the central bank is shifting its attention from a bond-buying stimulus program that is expected to be phased out this year to the challenge of raising interest rates as the economy and inflation accelerate.

"Participants generally agreed that starting to consider the options for normalization at this meeting was prudent," the minutes say.

Since the financial crisis, the Fed has bought more than $3 trillion in government bonds in an effort to inject money into the banking system and lower long-term interest rates to stimulate economic activity. Eventually, the securities will come off the Fed's balance sheet as they mature or the central bank sells them but that could take years.

Meanwhile, many Fed policymakers have predicted the central bank will begin raising its benchmark short-term interest rate — near zero since the crisis — sometime next year. But ensuring that those rate hikes succeed in controlling inflation by triggering increases in bond yields, bank interest rates and other borrowing costs can be challenging with so much cash sloshing around the banking system.

The Fed is weighing several tools to raise interest rates in the broader economy, including increasing the interest the central bank pays banks to park money at the Fed. Fed officials are also considering reverse repurchase agreements, or reverse repos, in which the Fed effectively borrows money from banks overnight at a fixed interest rate to sop cash from the financial system.

New York Fed chief William Dudley said in a speech Tuesday that reverse repos would put a floor under money market rates.

Another option is a "term deposit facility" in which the Fed would pay banks a higher interest rate to keep their money at the! central bank for a longer period.

The minutes indicate that the Fed made no decisions last month on which options it will choose.

"Because the Federal Reserve has not previously tightened the stance of policy while holding a large balance sheet, most participants judged that the Committee should consider a range of options and be prepared to adjust the mix of its policy tools as warranted," the minutes say.

Some policymakers said the Fed should better explain its plan to keep interest rates unusually low even after unemployment returns to normal levels, the minutes show. Fed Chair Janet Yellen has said that rates will remain low in part because the deep scars left by the recession may continue to hamper growth.

And "a number" of Fed officials suggested the Fed should provide more information on how long it will maintain its unusually large balance sheet.

At the meeting, the Fed agreed to further cut its monthly purchases of Treasury bonds and mortgage-backed securities to $45 billion to $55 billion. Yellen recently told Congress she expects the purchases to be halted sometime in the fall.

In a post-meeting statement, the Fed said the economy had gained momentum after adverse winter weather slowed activity early in the year--a view echoed in the minutes. But the minutes indicate that some policymakers "remarked that it was too early to confirm that the bounceback in economic activity would put the economy on a path of sustained above-trend economic growth."