Key Challenges Facing Federal Reserve
Policymakers
College Fed Challenge Orientation
Federal Reserve Bank of New York
Raymond W Stone
Stone & McCarthy Research Associates
June 16, 2008
Taylor Rule—Fed Buying “Insurance”
Against “Adverse Feedback Loop”
“Adverse Feedback Loop”
• A situation in which a tightening of credit
conditions could depress investment and
consumer spending, which, in turn, could
feed back to a further tightening of credit
conditions.
Price of Insurance—The Possible De-anchoring of
“Inflation Expectations”
Weak Dollar, Higher Import
Prices: Risk to Inflation
Credit Crisis: Strains in Term
Interbank Funding
Bank Funding Strains—More Restrictive Credit
Availability to Households and Businesses
Credit Crisis Response: Adding
to the Fed’s Tool-Kit
• Changes to Discount Window Policy (lower
spread over Funds target, longer borrowing
terms)
• Term Auction Facility (TAF)
• Single Tranche 28-Day RPs
• Term Security Lending Facility (TSLF)
• Primary Dealer Credit Facility (PDCF)
FRBNY Summary Table
http://www.newyorkfed.org/markets/Forms_of_Fed_Lending.pdf
Fed’s Role in Facilitating Acquisition of Bear
Stearns By JP Morgan Chase
• Why?
• Moral Hazard Debate
• Good Idea or Bad Idea?
Geithner’s Defense of Fed Actions with Regard to
Bear Stearns
• We did this with great reluctance, and only because it was the only
feasible option available to avert default, and because we did not
believe we had the ability to contain the damage that would have been
caused by default.
• Our actions were guided by the same general principles that have
governed Fed action in crises over the years. There was an acute risk to
the stability of the system; we were not confident that the damage
could be contained through other means; we acted only to help
facilitate an orderly resolution, not to preserve the institution itself; and
the management of the firm and the equity holders of the institution
involved suffered very substantial consequences.
Bear Stearn’s Ultimate Impact on
Fed’s Balance Sheet
Credit Crisis Innovations and the
Fed’s Balance Sheet
Ch gs Fe de ra l Re se rve Ba la n ce Sh e e t
( De c 5 , 2 0 0 7 t o Ju n e 4 , 2 0 0 8 )
Week ly averages ($blns)
asset s
liabilt ies
- $292.8 Ou t r ig h t s
$0.6 Re se r v e Ba la n ce s
$67.3 RPs
$150.0 T AF Cr e d it
$5.3 Cu r r e n cy in Cir cu la t io n
$8.3 PDCF Cr e d it
- $0.1 T r e a su r y De p o sit s
$15.7 Ot h e r Disco u n t Ad v a n ce s
$3.0 Re v e r se RPs ( F o r e ig n Of f icia l)
$0.0 Re v e r se RPs ( De a le r s)
- $0.5 F lo a t
$62.9 Ot h e r F R Asse t s
( includ ing SW A P d r awing s)
$2.0 All Ot h e r Lia b ilit ie s & Ca p it a l
$10.8 T o t a l Re se r v e Ba n k Cr e d it
$0.0 Go ld sto ck
$10.3 F a ct o r s Ab so r b in g Re se r v e s
$0.0 Special Drawing Rights
$0.0 Treasury Currency Outstanding
$10.8 T o t a l Fa ct o r s Su p p ly in g Re se r v e s
$10.8 T o t a l Lia b ilit ie s & Ca p it a l
Changing Composition of Reserve Bank
Credit—Fed Assets
Constraints on the Fed’s Balance Sheet
• Size of System Open Market Account—
Could the Fed run out of Treasury
Securities?
• Collateralization of Federal Reserve Notes
(relaxed by amendments to Federal Reserve Act)
Had the Federal Reserve Act Not Been Amended in
1999, The Fed Wouldn’t Have Been Able to Address
the Credit Crisis Effectively
Possible Solutions to Balance
Sheet Constraints
• Paying Interest on Bank Reserves
• Fed Issuing Debt to Fund Expansion of
SOMA
• Changes in Treasury Cash Management
Practices
Paying Interest on Bank Reserves: Impact on Sweep
Accounts and Required Reserves, as well as demand
for Excess Reserves
Demand f or Ex cess Reserves increases due t o int erest on Reserve balances
.
.
f
u
n
d
s
.
.
S
.
.
.
.
.
.
r
a
t
e
S'
.
.
.
.
.
.
.
funds tar get
.
.
----->
.
.
.
.
.
.
.
.
Balance Sheet
increased by
magnit ude of
shif t in t he
Supply Curve
reserves
.
.
.
.
D'
D
The Goodfriend Approach
We Can Reduce Risk In the Financial System
(Op-Ed article FT 6/8/2008)
Timothy Geithner, President FRBNY
http://www.ft.com/cms/s/0/807c8a64-355a-11dd-998d-0000779fd2ac.html
(1)
(2)
(3)
Increase the shock absorbers held in normal times against bad
macroeconomic and financial outcomes….more exacting
expectations on capital, liquidity and risk management for the
largest institutions that play a central role in intermediation and
market functioning.
Improve the capacity of the financial infrastructure to withstand
default by a big institution.
Supervision has to ensure that counterparty credit risk management
in the supervised institutions limits the risk of a rise in overall
leverage outside the regulated institutions that could threaten the
stability of the financial system.
Geithner Continued
•
Streamline and simplify the US regulatory framework…The institutions that
play a central role in money and funding markets – including the main globally
active banks and investment banks – need to operate under a unified
framework that provides a stronger form of consolidated supervision, with
appropriate requirements for capital and liquidity.
• A stronger capacity to respond to crises. The Fed has put in place a
number of innovative new facilities that have helped ease liquidity
strains. We plan to leave these in place until conditions in money and
credit markets have improved substantially. Some of these could
become a permanent part of our instruments. Some might be best
reserved for the type of acute market illiquidity experienced in this
crisis.