In the summer of 2010, Federal Reserve Chairman Ben Bernanke was in a difficult position. During the financial crisis of 2007–2009, the Fed had undertaken extraordinary policy actions to keep the financial system from imploding.
The crisis deepened in the fall of 2008 following the bankruptcy of the Lehman Brothers investment bank. At this time, the Fed made huge asset purchases that greatly increased the size of its balance sheet, bank reserves, and the monetary base. The Fed’s hope was that in two years, the economy would be in the middle of a strong recovery, and the Fed could begin what Bernanke called its “exit strategy.”
Although the Fed never described it in detail, the exit strategy was the process by which it would shrink its balance sheet and return bank reserves and the monetary base to more normal levels. Unfortunately, as Bernanke testified before Congress in late July 2010, the economy was recovering from the 2007–2009 recession more slowly than the Fed had hoped. In the second quarter of 2010, real GDP had increased by only 1.7% at an annual rate.
This growth rate was too slow to expand employment sufficiently to bring down the unemployment rate, which remained well above 9%.Would the economy grow more rapidly in the second half of the year? Bernanke called the outlook “unusually uncertain.”
Although growth in real GDP increased to 2.0% in the third quarter of 2010, in early November, the Fed announced a second round of quantitative easing under which it would buy $600 billion in long-term Treasury securities. The public focus on Bernanke and his colleagues at the Fed was not unusual. Although in early 2009, Congress and President Barack Obama had enacted a fiscal policy action that involved substantial increases in government spending and reductions in taxes, most macroeconomic policy consists of monetary policy initiatives from the Fed.
Fiscal policy involves changes in government spending and in taxes that require action by the president and the 535 members of Congress—a process that can be laborious and time consuming. But monetary policy is concentrated in the hands of the Fed’s Board of Governors and Federal Open Market Committee (FOMC).
In practice, power over monetary policy is even more concentrated because both the Board of Governors and FOMC typically defer to the chairman’s policy proposals. So, it was not surprising that Bernanke was the center of attention as the economy struggled through a slow recovery in 2010.
Although we can easily identify the goals of monetary policy, as Ben Bernanke acknowledged during 2010, it is not always so easy to enact policies that achieve those goals. The Fed has a limited number of monetary policy tools to use in attaining its goals. The Fed uses its policy tools primarily to change the money supply and short-term interest rates.
During the financial crisis, though, the Fed had to move beyond a focus on the money supply and short-term interest rates, as it attempted to reach its goals. We describe how the Fed conducts monetary policy and we identify the difficulties the Fed encounters in designing effective monetary policies.
No comments:
Post a Comment