At this point in the economic crisis, the severity of the malaise points to expectations of a lower federal funds rate, which the Fed may deliver sooner rather than later.
At this point in the economic crisis, the severity of the malaise points to expectations of a lower federal funds rate, which the Fed may deliver sooner rather than later. On October 15, 2002, Governor Bernanke presented a framework for Fed policy regarding asset-market instability. His remarks are appropriate (see excerpt below, FRB Speech, Bernanke — Asset-price "bubbles" and monetary policy — October 15, 2002) and the Fed has executed its responsibility of lender-of-last resort in a fitting manner.
“The second part of my prescription is for the Fed to use its regulatory, supervisory, and lender-of-last-resort powers to protect and defend the financial system. In particular, alone and in concert with other agencies, the Fed should ensure that financial institutions and markets are well prepared for the contingency of a large shock to asset prices. The Fed and other regulators should insist that banks be well capitalized and well diversified and that they stress-test their portfolios against a wide range of scenarios. The Fed can also contribute to reducing the probability of boom-and-bust cycles occurring in the first place, by supporting such objectives as more-transparent accounting and disclosure practices and working to improve the financial literacy and competence of investors.3 Finally, if a sudden correction in asset prices does occur, the Fed’s first responsibility is to do its part to ensure the integrity of the financial infrastructure–in particular, the payments system and the systems for settling trades of securities and other financial instruments. If necessary, the Fed should provide ample liquidity until the immediate crisis has passed.”
We need to step back and ponder about the benefit of additional easing of monetary policy. There are strong expectations that a significant stimulus program will be implemented shortly. A fiscal stimulus program may be more effective in stimulating demand and bringing about a recovery than additional easing of monetary policy. Also, the recapitalization of banks, that is underway, should eventually erase the credit crunch and revitalize lending to the private sector, which is the key to a full-fledged economic recovery. These factors support considerations of watching rather than acting immediately.
Fed Changes Interest Rate Formula Applied to Reserves
On November 5, the Fed changed the recently instituted formula for determining interest payment for reserve balances of banks held at the Fed. As of reserve maintenance period starting November 6, required reserves will be paid the average target federal funds rate and excess reserves will be paid the lowest target federal funds rate for the reserve maintenance period. In other words, there will be a difference in the interest rate paid on required and excess reserves only if the Fed changes the federal funds rate during the two-week period.