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Policy Tools

Two members of the FOMC gave very similar speeches last week. Their message? In preparation for the next economic downturn, we need to define the “expansion” of tools we used during the the Great Recession. As always, I can be reached for comments, feedback, or questions on twitter or via my website www.thebanksterpodcast.com.

Introduction

I am Alexander Bagehot and you’re listening to The Bankster Podcast, the only podcast dedicated to the fascinating and ever more consequential world of central banking.

Two members of the FOMC gave very similar speeches last week. Their message? In preparation for the next economic downturn, we need to define the “expansion” of tools that a central bank has in order to combat and prevent crisis.

On today’s short episode I’ll give a brief summary of the ideas shared by Charles Evans, President of the Chicago Federal Reserve, and John Williams, President of the San Francisco Federal Reserve. After the summary of their comments I will outline the policy tools used during the Great Recession by the Federal Reserve.

The Argument

The basic argument behind the need to clarify and define the policy tools the Central Bank will use goes something like this: the Fed won’t be able to raise interest rates as high as they were before the crisis. In 2006 the Fed Funds rate peaked at 5.25%. The most recent projections from the Fed’s Dot Plot show most participants believe the long run Fed Funds rate will settle at or around just 3.00%.  

Remember that the well established monetary policy tool that central banks use is a direct influence over the short term Fed Funds interest rate. The more dire the economic situation the more the Fed will lower the interest rate. When the next crisis comes, instead of being able to lower the Fed Funds rate from 5.25% to 0.00%. They’ll only be able to drop it from 3.00% down to 0.00%. That’s kind of like only being able to punch the bad guy half as hard as we did before.

At the next financial crisis the Fed will almost certainly lower the Federal Funds rate much quicker and will reach what economists call the Lower Zero Bound much sooner. When this happens the Fed will have to turn to “unconventional policy tools”. What Presidents Evans and Williams argued in their speeches last week is that in order to be prepared for the next crisis, the Fed needs to outline, research, and define the policy tools that they will use after hitting the Lower Zero Bound of short term interest rates.  

The Policy Tools

So in the spirit of preparation for the upcoming (hopefully not for many years) financial crisis, let’s review the policy tools that the Federal Reserve has or could use. We start with the ones that they used during the Great Recession and then I’ll describe just a few other’s that have been proposed by academics within and outside of the Fed.

 

  • Lower target range to 0-.25%

  • Buy bonds (gov debt, other; short, long term; operation twist)

  • Lending facilities (see new chart here)

  • Forward guidance

  • New inflation target (price targeting)

  • Negative Interest Rates

 

Conclusion

As always, I can be reached for comments, feedback, or questions on twitter or via my website www.thebanksterpodcast.com. If you’d like to receive the shownotes to every episode the morning every episode is published go to the website and sign up at the bottom of the home page. This week I’ll include a summary list of Policy Tools that Central Banks may use in the next financial crisis. The list will also include a link to the Lending Facilities summary chart that I created for the website.

Before we close out the episode I want to say that Janet Yellen announced this past week that she will be stepping down from the Board of Governors when her term as Chair ends in February. This is a sad loss to the Centralverse. She was the most qualified of any Federal Reserve Chair in its 100 year history and led the institution through one of the most successful economic expansions in the history of this country. On this Thanksgiving Day - we’re grateful for your service Chair Yellen and wish you a delightful and well deserved retirement. I hope your life’s memoir is not long in coming!

Today’s episode was written, edited, and produced by me, Alexander Bagehot. Thanks to all of you for listening, and I’ll see you next time on The Bankster Podcast!

 

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