Abstract
The financial dimension of the current contraction has brought a historic expansion in government lending to financial market participants, mostly through an expanding array of Federal Reserve (Fed) initiatives. This contrasts with the Fed's typical response to recent recessions that has been limited to adjustments of the target Fed funds rate. Restrictions on credit supply and declines of creditworthiness have both contributed to the contraction in lending, although the latter cause has probably been underestimated relative to the former. Fed and other government lending programs have targeted particular sectors, altering the allocation of credit across markets. Also, targeted credit programs contribute to the moral hazard problem inherent in the provision of government-funded credit or guarantees. An alternative approach to monetary policy where the Fed funds target is essentially zero is purchasing Treasuries, which is likely to have little effect on the relative credit spreads on different financial instruments. However, given that targeted lending has taken place, it is critical that regulatory mechanisms be installed so that government regulation matches the scope of government support. Also, targeted lending by the Fed is in effect fiscal policy. Is this a legitimate role for a central bank, or should such lending be subject to legislative approval, with the Fed's role limited to monetary stability?
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Notes
For a model in which it is optimal for credit standards vary over the business cycle, see Weinberg (1995).
For details on the Fed's credit market interventions, see www.federalreserve.gov/monetarypolicy/bst.htm.
The two do not necessarily move together one-for-one. Since last September, the U.S. Treasury has issued notes through the Supplementary Financing Program and deposited the proceeds with the Federal Reserve, effectively draining reserves from the banking system.
Although Federal Reserve staff may have unique skills and expertise, there is ample precedent for sharing skills with the Treasury; for example, the Treasury contracts with the Federal Reserve Banks to perform fiscal agency functions.
For narrative accounts of the events leading to the 1951 Treasury-Federal Reserve Accord, see the articles by Hetzel and Leach [2001a, 2001b] in the Federal Reserve Bank of Richmond Economic Quarterly Special Issue commemorating the 50th anniversary of the Accord. That issue also contains the article by Goodfriend [2001] quoted below, as well as a related article by Broaddus and Goodfriend [2001], The associated website contains historical documents, biographies, and additional material. Go to www.richmondfed.org/research and click on “Treasury-Fed Accord Special Report.”
See also Plosser [2009].
The commitment problems inherent in the financial safety net are discussed by Goodfriend and Lacker [1999] and by Stern and Feldman [2004].
References
Broaddus, Alfred J. Jr., and Goodfriend, Marvin . 2001. “What Assets Should the Federal Reserve Buy?” Federal Reserve Bank of Richmond Economic Quarterly, 87 (1): 7–22.
Goodfriend, Marvin . 2001. “Why We Need an ‘Accord’ for Federal Reserve Credit Policy: A Note.” Federal Reserve Bank of Richmond Economic Quarterly, 87 (1): 23–32. reprint of a 1994 article in Journal of Money, Credit, and Banking, 26(3): 572–580.
Goodfriend, Marvin, and Lacker, Jeffrey M. 1999. “Limited Commitment and Central Bank Lending.” Federal Reserve Bank of Richmond Economic Quarterly, 85 (4): 1–27.
Hetzel, Robert L., and Leach, Ralph F. 2001a. “After the Accord: Reminiscences on the Birth of the Modern Fed.” Federal Reserve Bank of Richmond Economic Quarterly, 87 (1): 57–65.
Hetzel, Robert L., and Leach, Ralph F. 2001b. “The Treasury-Fed Accord: a New Narrative Account.” Federal Reserve Bank of Richmond Economic Quarterly, 87 (1): 33–55.
Kareken, John . 1983. “Deposit Insurance Reform or Deregulation is the Cart, Not the Horse.” Federal Reserve Bank of Minneapolis Quarterly Review, 7 (2): 1–9.
Plosser, Charles . 2009. “Ensuring Sound Monetary Policy in the Aftermath of Crisis,” Speech to U.S. Monetary Policy Forum, New York, NY, February 27.
Stern, Gary H., and Feldman, Ron J. 2004. Too Big to Fail: The Hazards of Big Bank Bailouts. Washington, DC: The Brookings Institution Press.
Weinberg, John . 1995. “Cycles in Lending Standards?” Federal Reserve Bank of Richmond Economic Quarterly, 81 (3): 1–18.
Working Group on Financial Reform, 2009. Financial Reform: A Framework for Financial Stability. Group of Thirty, January 15.
Acknowledgements
I am grateful to John Weinberg, Senior Vice President, and Director of Research, for help in preparing this speech.
Additional information
*Jeffrey M. Lacker is the President of the Fifth District Federal Reserve Bank, at Richmond, having taken office on August 1, 2004. He is currently serving as a full term that began March 1, 2006. In 2009, he serves as a voting member of the Federal Open Market Committee. He received his bachelor's degree in economics from Franklin and Marshall College in 1977. Following graduation, Dr. Lacker joined Wharton Econometrics in Philadelphia. He went on to earn a Ph.D. in economics from the University of Wisconsin in 1984. Dr. Lacker was an assistant professor of economics at the Krannert School of Management at Purdue University from 1984 to 1989. He joined the Bank in 1989 as an economist in the banking area of the Research Department. He was named research officer in 1994, Vice President in 1996, and senior Vice President and Director of the Research Department in May 1999. He taught at the College of William and Mary in 1992 and 1993, and in 1997, he was a visiting scholar at the Swiss National Bank. Dr. Lacker is the author of numerous articles in professional journals on monetary, financial, and payment economics, and has presented his work at several universities and central banks, and also presented at the National Association for Business Economics 2009 Washington Economic Policy Conference, Alexandria, Virginia, March 2, 2009.
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Lacker, J. Government Lending and Monetary Policy. Bus Econ 44, 136–142 (2009). https://doi.org/10.1057/be.2009.12
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DOI: https://doi.org/10.1057/be.2009.12