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January 15, 2009
What, exactly, is the Fed trying to do?
There has been, of late, no shortage of official voices devoted to answering the question posed in the title of this post. Chicago Fed President Charles Evans, San Francisco Fed President Janet Yellen, Richmond Fed President Jeff Lacker, Philadelphia Fed President Charles Plosser, and Chairman Bernanke have all given speeches in the last two weeks outlining their version of answers to this question. Add to that list Federal Reserve Bank of Atlanta President Dennis Lockhart, who laid out his own views at a speech to the Atlanta Rotary Club this past Monday and again today at the University of Southern Mississippi's Outlook for South Mississippi Conference. Here's what he said:
"The Fed, as the country's central bank, conducts monetary policy—as distinct from fiscal policy—under legal mandates set down by Congress. The Fed's mandated policy objectives—the so-called dual mandate—are sustainable economic growth along with low and stable inflation.
"The mandates have not changed. But what has changed is some aspects of how we pursue those objectives. Extraordinary circumstances this last year and a half have required the Fed to expand the set of tools employed to meet those objectives."
What is the practical implication of those circumstances?
"The federal funds rate is a very general tool and one that relies on the functioning of credit markets to have its intended effects. But, as you know, credit markets have not been functioning normally even in markets strongly backed by the U.S. government, such as agency (e.g., Fannie Mae and Freddie Mac) mortgage-backed securities….
"Among the programs in force is the direct purchase of agency (Fannie Mae, Freddie Mac, etc.) notes and mortgage-backed securities. These securities are directly linked to mortgage rates. Purchases began just a few days ago. The goal of such a program is not, in my view, to engineer a particular interest rate level, that is, to hit a particular rate target. But direct purchases can promote directionally lower rates, help restore normal market functioning, and thereby achieve a return to reliance on private sector market-based credit allocation.
"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."
Sometimes, if I may paraphrase, deviating from business as usual is the best way back to business as usual.
By David Altig, senior vice president and research director at the Atlanta Fed
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