On reading speeches of three regional Fed Presidents, one gets a common theme- worry over Fed’s expanding and risky balance sheet. They say the main idea is not how to support falling financial markets but to draw a line (I mentioned this in my previous post). The speeches are from – Jeffrey Lacker of Richmond Fed, Thomas Hoenig of Kansas Fed and Dennis Lockhart of Federal Reserve Bank of Atlanta.
The monetary liabilities of the Federal Reserve Banks have more than doubled over the last several months, from around $840 billion the week ending September 11, to around $1.7 trillion the week ending December 31. Virtually all of this increase was in the form of bank reserves – the deposit balances that banks hold at their Federal Reserve Banks – which went from $8 billion to $848 billion over that period. (The rest of the monetary base consists of paper currency.) This increase in the Fed’s money supply was a consequence of the collection of credit programs initiated last fall.
But monetary policy and credit programs do two different things. Monetary policy stabilizes the purchasing power of money over time by keeping the price level stable and relatively predictable, and by doing so, contributes to maximum sustainable economic growth. Credit policy is also aimed at promoting growth, but it is more a form of fiscal policy in that it uses the public sector’s balance sheet to alter the allocation of resources. In this instance, credit market interventions have been financed to some degree by the issue of new monetary liabilities, but they could just as well be financed with non-monetary liabilities, such as U.S. Treasury securities.
Both the short-term benefits and the long-term costs of central bank credit have been and will no doubt continue to be debated for some time to come. But no matter how one assesses the overall merits of such programs, it is important to recognize that these are fiscal measures that are distinct from monetary policy. While at the present time, credit programs do not conflict with our monetary policy strategy, there could well come a time at which monetary stimulus needs to be withdrawn to prevent a resurgence of inflation, even though credit markets are not deemed fully healed. At that time, containing inflation may require closing down credit programs, or finding an alternative, non-monetary financing arrangement for them. Price stability, after all, is the vital first ingredient in financial market stability.
Hoenig ( the content can’t be extracted from pdf file so am just summarising his main idea)says that Fed has taken the role of financial industry’s role as intermediary to business firms. This is a dramatic expansion of Fed’s role in economy. Hence, it musty design an exit strategy as well and should not undermine the functioning of financial markets.
Lockhart (he calls it new monetary policy):
Initially, as the Fed responded to credit market strains, the focus was on interbank markets. But, as problems spread, the Fed introduced almost a dozen targeted credit and financial market facilities.
The introduction of targeted asset-side measures has been aimed squarely at the breakdown of credit markets, the circulatory system of our modern economy. In my view, a precondition of economic recovery is the return of the normal functioning of credit markets.
Let me emphasize that this asset-focused approach is a departure from what the textbooks describe as conventional monetary policy and is not without controversy. Some have called it credit policy to distinguish it from the conventional approach where the central bank achieves its objectives through its influence on bank reserves on the liability side of the balance sheet.
I don’t often use slides in speeches, but I want to show you this image because it so clearly illustrates this new approach and, I believe, helps to answer the second question I posed at the outset. And that is, how will the Fed go about accomplishing the policy objectives I described earlier by using the asset side of its balance sheet?
As the graph shows, there are two aspects of this policy approach—growth of the Fed’s balance sheet in absolute terms and change of the composition of assets. Even with the federal funds rate effectively at zero, there is ample scope to do more of both if conditions require.
To sum up, Lacker is quite sceptic and calls monetary policy a credit policy which is trying to achieve fiscal policy objectives. Hoening specifies the need to have an exit strategy which is also mentioned by Lacker. Lockhart does not specify his stance clearly and is hopeful things work out (just like FRBSF President Janet Yellen).
On these counts one should expect some dissent note from these members in the FOMC meeting (esp from Lacker). I checked the minutes of the recent meeting held on 15-16 Dec 2008 and except Koenig all three were alternate members.
FOMC comprises 12 members:
7 Board Members (permanent)
1 President of NY Fed (permanent)
4 members* (chosen from 11 Fed regions)
* The members from 11 regions are on a rotation basis. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. (If you see the map, there is no clarity on the formation of the groups. I will have to check Fed history for this. )
Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee’s assessment of the economy and policy options. These are named as Alternate Members as well.
The FOMC page also gives the rotating members in 2008, 2009 and 2010 as well. In 2008 – Cleveland, Philadelphia, Dallas and Minneapolis were the members and Chicago, Richmond, Atlanta and San Francisco were alternate members. In 2009 Chicago, Richmond, Atlanta and San Francisco would be members and Cleveland, Boston, St. Louis & Kansas City as alternate members.
Though, Richmond (Lacker) was an alternate member, he could have expressed his dissent/suggestion on the actions and the minutes would have captured the same . However, we don’t see anything ( I checked minutes since Sep 2008 and found nothing as well). In 2009, it is a FOMC member so may be we see something. Atlanta s also going to be a FOMC member. Likewise, Kansas (Hoenig) would be an alternate member in 2009 and so lets see if we see some dissent/suggestion from the same.
So, would the concerned members mention or instead do what we have been seeing in US policymaking – flip (say/research something and suggest different policies). I had previously written a post comparing the speech of 2 Bank of England MPC member with their actions and found they walked the talk. I remember economists criticising Greenspan as it seemed he carried a lot of weight in FOMC policies and it was his vote that mattered. There were hardly any dissenters. With Bernanke, this increased. We hope this continues.
One should also read WSJ Blog’s posts on the same issue -
Does Fed Policy Marginalize Regional Bank Presidents?
The End of Dissent: Fisher Joins the Majority
Richmond Fed’s Lacker: Recession Yes, Rate Cuts No