Fed testing inflation-busting tool

March 23, 2011, 7:00 PM UTC

The world is awash in dollars, but the Fed wants you to know it hasn’t forgotten about the need to clean up after itself — one of these days.

The central bank said Wednesday it will run another test of a tool it rolled out two years ago to drain money from the banking system.

Not an enviable position

The idea is to make sure that so-called reverse repurchase agreements – in which the Fed swaps Treasury securities and the like for balances available in money funds and banks, in a bid to shrink the amount of cash in the system — will help hold down inflation when doing so becomes a priority for policymakers again.

The New York Fed will run small-scale tests of the reverse repos starting Thursday, it said in a statement. The markets are awash in inflation talk, but central bankers here remain leery of pulling back support for an economy that is already likely to be slowed in the second half by budget-related fiscal tightening.

It is possible, if not likely, that Fed chief Ben Bernanke will comment on the Fed’s view when he speaks this afternoon at a community banking conference. But from all indications it will be at least a year and perhaps more before the Fed starts actually using tools like the reverse repos, let alone actually raising interest rates.

As Bernanke well knows, he has miles to go before can think about an exit.

Also on Fortune.com:

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