Yesterday, the House Financial Services Committee held a hearing entitled "Unwinding Emergency Federal Reserve Liquidity Programs and Implications for Economic Recovery." Testifying before the Committee were the following witnesses:
- Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System
- Larry Meyer, Vice Chairman, Macroeconomic Advisers
- John B. Taylor, Mary and Robert Raymond Professor of Economics, Stanford University
- Marvin Goodfriend, Professor of Economics and Chairman of the Gailliot Center for Public Policy, Tepper School of Business, Carnegie Mellon University
- Laurence Ball, Professor of Economics, Johns Hopkins University
Committee Chairman Barney Frank (D-MA) began the hearing by noting the active role that the Federal Reserve has taken and commending it for providing liquidity, which helped to "diminish negative effects." However, he noted that the Federal Reserve needs to undo these measures in way that will not adversely affect the taxpayer or the economy as a whole. Chairman Bernanke began by referencing his earlier prepared testimony for the February 10, 2010 hearing that was cancelled because of inclement weather. Chairman Bernanke noted that the Federal Reserve's response to the economic crisis could be divided into two broad areas: (1) the provision of liquidity, as the lender of last resort, during a period of "intense panic and dysfunction, during which private short-term funding became difficult or impossible to obtain for many borrowers"; and (2) "both standard and less conventional forms of monetary policy." According to Chairman Bernanke, the Federal Reserve has "substantially phased out" the first set of liquidity measures. With respect to the second class of measures, the Federal Reserve lowered short-term interest rates to nearly zero and performed "large-scale purchases of Treasury securities, agency mortgage-backed securities (MBS), and agency debt." Chairman Bernanke noted that "We believe that it's getting more and more difficult for us to justify our unusual and exigent emergency powers in the context of a market that is improving, but we recognize there are a lot of issues, still."
Bernanke continued "At its meeting last week, the FOMC maintained its target range for the federal funds rate at 0 to 1/4 percent and indicated that it continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. In due course, however, as the expansion matures, the Federal Reserve will need to begin to tighten monetary conditions to prevent the development of inflationary pressures. The Federal Reserve has a number of tools that will enable it to firm the stance of policy at the appropriate time." In addition, the Federal Reserve is currently establishing methods for reducing the amount of reserves held by the banking system. In order to achieve this goal, Chairman Bernanke proposed "expand[ing] its range of counterparties for reverse repurchase operations beyond the primary dealers and to develop the infrastructure necessary to use agency MBS as collateral in such transactions" and offering to "depository institutions term deposits, which are roughly analogous to certificates of deposit that the institutions offer to their customers." Chairman Bernanke concluded by noting that that "The economy continues to require the support of accommodative monetary policies. However, we have been working to ensure that we have the tools to reverse, at the appropriate time, the currently very high degree of monetary stimulus. We have full confidence that, when the time comes, we will be ready to do so."
The second panel, consisting primarily of academic economists, echoed Chairman Bernanke's emphasis on a careful withdrawal from the extraordinary measures taken during the financial crisis. Mr. Meyer stated "There are three actions that define the Fed’s exit from its extraordinarily accommodative policy: actively withdrawing reserves, raising the policy rate, and shrinking the Fed’s balance sheet." Mr. Taylor focused on the risks inherent in winding down liquidity programs, the possibility of inflation and how the current measures endanger the Federal Reserve's independence. According to Mr. Taylor, Federal Reserve independence is undermined because instead of focusing on monetary policy, it has "help[ed] some firms or sectors and not others ... through money creation rather than taxes or public borrowing" and thereby engaged in "fiscal policy," credit allocation policy" and "monodustrial policy." Mr. Taylor concluded "The measures taken during the panic likely helped rebuild confidence and stabilize markets. The measures taken after the panic have had a rather small impact. The longer term consequences of these measures are negative and include risks to the Fed’s independence to conduct monetary policy, risks of inflation, and uncertainty about the impact of an exit strategy." Mr. Goodfriend agreed stating "More generally, I believe it is inadvisable for the Fed to utilize non-monetary “managed liabilities” on a large scale because they would turn the Fed into a “financial intermediary” and jeopardize its independence by facilitating the perpetual funding of credit policy independently of monetary policy." Mr. Goodfriend suggested this outcome can be avoided if the regulation of the federal funds market is modified to secure the potential for interest on reserves to put a floor under the federal funds rate.
Mr. Ball commended the Federal Reserve on its actions, stating "The unprecedented combination of new lending programs, large asset purchases, and near-zero interest rates has prevented a very painful recession from turning into something even worse. Without the Fed’s extraordinary policies, we could be facing a depression on the scale of the 1930s." Mr. Ball focused on the federal funds rate ands its relation to unemployment. He concluded that the Federal Reserve should not increase the federal funds rate until it sees "major progress in reducing unemployment," even if inflation starts to rise. "A moderate rise in inflation would probably be good for the economy."