Sunday, October 12, 2008

Fisher’s back! Not about inflation but liquidity

Dallas Federal Reserve Bank President Richard Fisher is back in the news. Earlier in the year, he was well known for his sometimes lone dissenting votes at the April, June, and August Federal Open Market Committee (FOMC) meetings; he was the ultimate hawk of the FOMC. Now he is back in business, suggesting that the use of new Fed liquidity measures – which have almost tripled the size of Fed’s policy toolbox since December 2007 - will be re-assessed going forward.

From the Wall Street Journal on Sunday:
“WASHINGTON -- The U.S. Federal Reserve has put in place a number of temporary facilities to inject liquidity into the financial system, which will have to be unwound at some point, Federal Reserve Bank of Dallas President Richard Fisher said Sunday.

The Fed will, however, have to determine what tools a central bank needs to operate in the 21st and 22nd centuries, Mr. Fisher told a conference organized by the Institute of International Finance.

Mr. Fisher was responding to a question about whether the Fed would eventually reduce the size of its balance sheet, which has ballooned in recent months as the central bank pumps hundreds of billions of dollars into the world's financial system.

Answering another question, Mr. Fisher said that there are pros and cons to mark-to-market accounting rules, and that this is an ‘issue that has to be dealt with’ to help resolve the current financial crisis.

There has been broad criticism of mark-to-market accounting, which makes institutions value their assets based on prevailing market prices. As a result of the financial crisis, many assets are valued at desperately low fire-sale prices, which many argue don't reflect their true value.

This is ‘one of many factors that needs to be taken into account,’ Mr. Fisher said.

Another questioner asked whether the Fed would resort to a competitive devaluation of the U.S. dollar to help the economy recover.

Mr. Fisher said the Fed's objective ‘is not to inflame any beggar-thy-neighbor policy.’ The Fed is ‘extremely mindful of the fact that the global financial system is interlinked he said, and the central bank will ‘most definitely not proceed along the lines you suggested.’”

RW: Since October 2007, the Fed’s balance sheet has more than doubled to roughly $1.5 trillion. The Fed has increased its holding of less liquid (and in some cases, illiquid) assets through the creation of innovative lending facilities at the end of 2007 and into 2008, which has reduced substantially its holdings of U.S. Treasuries – the Fed’s staple policy tool (open market operations).

Previous to 2008, the Fed’s policy toolbox included the following:

  • Open Market Operations (the Fed’s staple policy measure)
  • Reserve Requirements
  • The Discount Rate

Since December, the toolbox includes:

  • All of the above
  • Interest on Required Reserve Balances and Excess Reserves
  • Term Auction Facility
  • Primary Dealer Credit Facility
  • Term Securities Lending Facility
  • ABCP MMMF Liquidity Facility

Pres. Fisher suggests that the newly added and innovative lending facilities will not be needed going forward, as a restructuring of the banking system (e.g., changes in the mark-to-market accounting rules) gets underway well into the 22nd century (if the Fed knows what policy tools will be needed 92 years from now, they should have been able to forecast better the crash of the credit system).

As a side note, I despise reporters when they ask stupid questions like if the “the Fed would resort to a competitive devaluation of the U.S. dollar.” Of course the Fed will not peg the U.S. currency to increase the competitiveness of U.S. exports (i.e., make them cheaper for foreign economies). To even suggest such a thing is a waste of the President’s time, as a currency peg would simply negate the effectiveness of monetary policy in dealing with domestic economic conditions. The Fed has not intervened in currency markets since 2000, when it support of the introduction of the Euro by purchasing 1.5 billion of the new currency.

Rebecca Wilder

1 comment:

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