The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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May 29, 2009

A new accord?

As days go in the U.S. Treasury market, Wednesday was a rough one. Bloomberg News described the day's developments as follows:

"The difference in yields between Treasury two- and 10-year notes widened to a record on concern surging sales of U.S. debt will overwhelm the Federal Reserve's efforts to keep borrowing costs low. …

"The unprecedented government borrowing has created concern about a rise in consumer prices. Policy makers have expanded the Fed's balance sheet to $2.2 trillion while excess reserves at U.S. banks have increased to $896.3 billion.

" 'Inflation is in the headlight of many investors,' wrote Andrew Brenner, co-head of structured products and emerging markets in New York at MF Global Inc., in a note to clients today."

By cosmic coincidence, I was reading that story in Tokyo as I prepared to chair a session at the Bank of Japan's 2009 International Conference on Financial System and Monetary Policy Implementation in which Marvin Goodfriend (Carnegie-Mellon professor and former Richmond Fed policy adviser) presented his thinking on keeping the central bank's inflation objectives firmly in hand at a time of rapidly rising government debt and large increases in the Fed's balance sheet. Professor Goodfriend's case is laid out in a paper titled "Central Banking in the Credit Turmoil: An Assessment of Federal Reserve Practice" (which was also presented at a conference devoted to research on the interactions between monetary and fiscal policy—that is, government spending and tax—co-sponsored by Princeton University's Center for Economic Policy Studies and Indiana University's Center for Applied Economics and Policy Research). Goodfriend pulls no punches:

"The 1951 'Accord' between the United States Treasury and the Federal Reserve was one of the most dramatic events in U.S. financial history. The Accord ended an arrangement dating from World War II in which the Fed agreed to use its monetary policy powers to keep interest rates low to help finance the war effort. The Truman Treasury urged that the agreement be extended to keep interest rates low in order to hold down the cost of the huge Federal government debt accumulated during the war. Fed officials argued that keeping interest rates low would require inflationary money growth that would destabilize the economy and ultimately fail.

"The so-called Accord was only one paragraph, but it famously reasserted the principle of Fed independence so that monetary policy might serve exclusively to stabilize inflation and the macroeconomic activity. …

"The enormous expansion of Fed lending today—in scale, in reach beyond depository institutions, and in acceptable collateral—demands an accord for Fed credit policy to supplement the accord on monetary policy. A credit accord should set guidelines for Fed credit policy so that pressure to misuse Fed credit policy for fiscal purposes does not undermine the Fed's independence and impair the central bank's power to stabilize financial markets, inflation, and macroeconomic activity."

Goodfriend's "new accord" amounts to asserting a set of principles that would reinforce price stability as the central goal of monetary policy, set the Fed down the road of extricating itself from the extraordinary credit market interventions of the past year-and-a-half, and join the central bank and Treasury in common cause toward the goal of doing everything possible to make sure that the Fed and Treasury don't go there again.

The paper was provocative, but it also raised a couple of fundamental questions. In particular, what is the degree of autonomous fiscal risk-taking appropriate to allocate to a central bank? If such powers are granted, how often and under what conditions ought those powers be exercised? And how far should the powers reach? If, as Goodfriend states, "the central bank's power to stabilize financial markets, inflation, and macroeconomic activity" requires lender-of-last-resort interventions—and hence pure credit policy interventions—what does that imply about the appropriate scope of monetary and regulatory authorities going forward? If the "shadow banking system" is the de facto banking system of the modern era—as Yale University's Gary Gorton argued in a paper presented at the Atlanta Fed's annual Financial Markets Conference held earlier this month—is the central bank's lender-of-last-resort function meaningful if narrowly construed (that is, if it fails to reach the shadow banking system)?

These, really, are first-order questions. On to the debate.

By David Altig, senior vice president and research director of the Atlanta Fed

May 29, 2009 in Federal Reserve and Monetary Policy , Fiscal Policy , Monetary Policy | Permalink


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There seems to me be some danger that the Federal Reserve may use its fiscal powers to lend rather too much support to banks at the expense of taxpayers. Banks enjoy something of the advantage of an employee with the office closest to the boss.

Posted by: don | May 29, 2009 at 07:29 PM

This is a fantastic debate to have. My hope is that the debate is kept out of the political sphere, but realistically I don't think that will be possible.

Is the Fed assuming too much risk that makes it too big to fail? What checks and balances need to be in place so that it can't, or are current checks and balances enough?

Clearly, Treasury Secretaries, President's of the US, and Congress have various viewpoints that can change like the breeze. So maybe it's better to redo the Feds charter and mission to encompass the new activities.

Personally, the sooner the Fed can empty its balance sheet of these new securities, the better.

Posted by: Jeff | June 03, 2009 at 08:06 AM

Is not the real problem to much of this that the Fed claims ownership of the money that is printed for it, then "lends" it to the US government? It did nothing to earn the money and does NOT own it, ongoing since 1913 ! Our national debt is a scam on the American public based on that horrid law that even Pres. Wilson decried as he signed it. Ron Paul's HR1207 MUST get out of committee...or FIRE mr. Barney Frank (chair)..for that and many other reasons!

Posted by: Tom Lamar | June 13, 2009 at 07:45 PM

Agree with don.

Posted by: Celeb Buster | July 31, 2009 at 10:53 AM

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