Revisit Fed-Treasury accord and we are moving to a policy driven crisis

Jeff Lacker of Richmond Fed in his speech:

While both the Fed and the Treasury can extend credit, only the Fed issues money. Thus, the Fed’s primary focus should be the management of its monetary liabilities.

Goodfriend advocated an understanding or agreement between Fed and Treasury on credit policy, analogous to the 1951 Accord.

A new “credit accord” that assigns to the Treasury the responsibility for all but very short-term lending to solvent institutions would have a number of advantages, I believe. On a practical level, at some point in the future, the Fed will need to withdraw monetary stimulus to prevent a resurgence of inflation when the economy begins to recover. That time could arrive before credit markets are deemed to be fully enough “healed” to warrant winding down particular credit programs. If monetary policy and credit programs remain tied together, as they currently are, we risk having to terminate credit programs abruptly, or else compromise on our inflation objective. Separating credit programs from monetary policy would make it easier to devise a successful “exit strategy,” and would reduce market uncertainty about how any potential tension between monetary and credit policy will be resolved.

Charles Plosser of  Philadelphia Fed in a speech:

Even more important, credit allocation decisions, in my view, should be under the purview of the fiscal authority, not the monetary authority, since they involve using the public’s money to affect the allocation of resources. The mixing of monetary policy and fiscal policy increases the number of entities that might try to influence Fed decision-making in their favor. Both economic theory and practice indicate that central banks should operate independently from such pressures and resist them when they arise so that their policies benefit society at large over the longer term and not any particular constituency in the near term.

So where should we go from here? One suggestion that would promote a clearer distinction between monetary policy and fiscal policy and help to safeguard the Fed’s independence would be for the Fed and Treasury to reach an agreement whereby the Treasury takes the non-Treasury assets and non-discount window loans from the Fed’s balance sheet in exchange for Treasury securities. Such an accord would offer a number of benefits.

Both mention the need to revisit the Treasury -Fed accord and ensure Fed does only mon policy and credit policy is left to Treasury. Fed may be asked to intervene early in the crisis  but eventually all credit programs should move to Treasury asap.

For more on Treasury-Fed accord see this Richmond Fed Study. This study tells the story of how Fed got its independence and was made responsible for monetary stability in US.

Now, all these are important developments. Till January 2009 all was accepted as ok by Fed members, now we  are seeing dissent (Lacker dissented in the latest Fed meeting) and discomfort. The members are increasingly showing concern with Fed policies and balance sheet. The worries over moral hazard is also increasing . The above  suggestions about revisiting the accord implies they are worried over Fed not being as independent as well.

In another much discussed speech, Kansas Fed President Koenig said (pointed by Krugman):

We have been slow to face up to the fundamental problems in our financial system and reluctant to take decisive action with respect to failing institutions. … We have been quick to provide liquidity and public capital, but we have not defined a consistent plan and not addressed the basic shortcomings and, in some cases, the insolvent position of these institutions.

We understandably would prefer not to “nationalize” these businesses, but in reacting as we are, we nevertheless are drifting into a situation where institutions are being nationalized piecemeal with no resolution of the crisis. 

The crisis is shifting from a financial crisis to a real economy crisis to a policy crisis..

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4 Responses to “Revisit Fed-Treasury accord and we are moving to a policy driven crisis”

  1. » Revisit Fed-Treasury accord and we are moving to a policy driven crisis Says:

    [...] GEO 12.97°N 77.56°E wrote an interesting post today onHere’s a quick excerptJeff Lacker of Richmond Fed in his speech : While both the Fed and the Treasury can extend credit, only the Fed issues money. Thus, the Fed’s primary focus should be the management of its monetary liabilities. Goodfriend advocated an understanding or agreement between Fed and Treasury on credit policy, analogous to the 1951 Accord. A new “credit accord” that assigns to the Treasury the responsibility for all but very short-term lending to solvent institutions would have a number of a [...]

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    [...] Revisit Fed-Treasury accord and we are moving to a policy driven crisis [...]

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  4. Increasing financial regulation or limiting usage of implicit safety net? « Mostly Economics Says:

    [...] Fed Presidents. Jeff Lacker dissented against Fed’s credit easing policy in FOMC meeting and spokeon the need to revisit Fed-Treasury Accord, Charles Plosser of Philadelphia also on the [...]

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