The Guest Blog

Tony Fratto: Exit Signs — Bernanke Will Map the Road Ahead

The snowstorm that slammed Washington, DC a couple of weeks ago brought work in the nation's capitol to screeching halt, including postponing Federal Reserve Chairman Ben Bernanke's anticipated congressional testimony.

Chairman Bernanke gets an opportunity to deliver that testimony today, focusing both on the Fed's plans for monetary policy, and the outlook for withdrawing the extraordinary programs put in place during the financial crisis.

One unintended consequence of delaying the hearing was that Bernanke was denied the opportunity to further signal his plans to begin to normalize the spread between the target federal funds rate and the discount rate. The Fed's announcement a week later that it would raise the discount rate last surprised some market participants.

At least, it surprised those who weren't paying attention. Markets won't make the same mistake today — every word by the Chairman will be duly parsed.

Bernanke's challenge today will be to convince skeptical members of Congress that he has a plan to manage his commitment to growth now and in the near term, while also being able to withdraw liquidity quickly enough to prevent inflation expectations from taking hold. Bernanke will also explain how the Fed will reduce a balance sheet that necessarily exploded during the financial crisis. No question - he has a complicated eighteen months ahead of him.

Snowstorm to Blame for Bad Reaction to Fed Move

Fortunately, Bernanke has some new tools in his toolbox to better fine tune monetary policy beyond the policy rate.

Whereas the federal funds rate is a blunt instrument, the Fed's ability to pay interest on reserves is more surgical.

Bernanke will also soon test special deposit accounts, another potentially powerful tool to drain excess liquidity.

The Fed's ability to better target reserves will help, but at the end of the day it will still come down to judgment calls by Bernanke and members of the Federal Open Market Committee on the outlook for demand in the economy, the magnitude and timing of tightening decisions, and -- equally important -- how those decisions are communicated.

Let's hope another snow storm doesn't get in Bernanke's way this time.

Tony Fratto is a CNBC on-air contributor and most recently served as Deputy Assistant to the President and Deputy Press Secretary for the Bush Administration.