Fed creates new tool to assist eventual tightening

The U.S. Federal Reserve on Friday authorized a new mechanism that it said can eventually be used to withdraw excess cash from the banking system.

The program, called the term deposit facility, enables Federal Reserve banks to pay interest on longer term deposits to firms already eligible to receive interest on the overnight reserves they hold at the Fed.

The Fed -- the U.S. central bank -- stressed in a statement that the development of the mechanism is a matter of prudent planning and has no implication for the near-term conduct of monetary policy. The Fed this week renewed its pledge to keep benchmark interest rates extraordinarily low, near zero, for an extended period.

The Fed said it expects to conduct small-value offerings of term deposits in coming months to test the mechanism.

Term deposits will be one of several tools that the Federal Reserve could employ to drain reserves when policymakers judge that it is appropriate to begin moving to a less accommodative stance of monetary policy, the Fed said.

In its effort to battle the worst financial crisis since the Great Depression, the Fed has deployed an extraordinary array of emergency measures, leading to a surge in its balance sheet to more than $2 trillion.

Other tools the Fed could use for tightening include large-scale reverse repurchase agreements and outright sales of assets.