Okay. Thank you. Let me just offer some thoughts that may be somewhat more expansive than usual in response to the questions that have been raised. Some of this is extemporaneous, so you’ll have to bear with me. Let me first talk about the strategy we pursued thus far and where we are and then think about where we might go as a country as well as an institution going forward.
Without going through all of the familiar discussion about how the crisis began, what the sources of it were, I think that the Federal Reserve’s responses are essentially three. First, we were relatively early and aggressive in our monetary policy easing, particularly compared with other countries. Second, we have been creative and expansive in our use of liquidity tools, including a wide variety of lending programs. Third, we have used our available, but not always adequate, tools to try to stabilize systemically critical failing institutions and to try to mitigate systemic risk.
Without sounding too defensive, I will try to argue that I think on all three of these we have been more or less in the right direction. First, on the early and aggressive monetary policy easing, obviously there was a lot of concern—a lot expressed abroad that we were going to create a stagflationary 1970s type of situation and that we were going to destroy the dollar and its role as an international currency. Our response essentially was that we thought that the increases in commodity prices were mostly a relative price change induced by changes in real demand for commodities and in the supply of commodities across the globe and that, at some point, those commodity price increases would stabilize, which would lead to a moderation of the inflationary effects and concerns. It took longer than we had expected; but once it began, it was more pronounced than we had expected. Inflation has not become the problem that was anticipated by many early on, and the dollar, of course, is now stronger than it was before we began our cutting of interest rates. So in retrospect, I think our monetary policy, although not perfect certainly—and our communication was not always perfect—broadly speaking was appropriate given what has turned out to be a very severe economic situation.
Liquidity expansion also received some criticism early on. There was a view that this was inducing moral hazard. There was also some question of whether this was an effective approach. We were helped in this respect by the fact that the ECB joined us very early in this type of aggressive policy. I don’t know the counterfactual. It has obviously not solved all of the problems. But I think there’s a strong perception in the markets and in the general public that these actions have been supportive, and they helped mitigate the effects of the crisis on the functioning of the financial system. So I feel comfortable also with that approach.
The attempts to stabilize failing systemically critical institutions, beginning with Bear Stearns, have obviously been very controversial. There have been criticisms from the right and from the left. From the right, the initial criticism was that we have no business interfering with the market process. We should let them fail. The market will take care of it. What are we doing? We heard this as recently as Jackson Hole. I never took this seriously. I just don’t believe that you can allow systemically critical institutions to fail in the middle of financial crises and expect it to be not a problem. I don’t want to get into the issue about the inconsistency. It’s true that we treated senior debt differently between Fannie and Freddie and WaMu and Wachovia, but I don’t think that that is the reason we are having the financial crisis we’re having. I think there was a panic brought about by the underlying concerns about the solvency of our financial institutions. That panic essentially turned into a run. Companies like Wachovia that had adequate Basel capital faced a run on their deposits, which was self-fulfilling. The investment banks essentially faced runs. We did our best to stabilize them, but I think that it was that run, that panic, and then the impact the panic had on these major institutions that was the source of the intensification of financial crisis. So I don’t buy the argument that we should stay out of the business of protecting the financial system, and I think that the major factor was, in fact, the panic that was generated by the underlying uncertainties and the effect that had on critical institutions.
Also more recently we have heard more of a critique from the left, which is, What in the heck were you guys doing letting Lehman fail? This is interesting given that the critique had been the other one for quite a while. I think that critique is unfair at a narrow level in that, first, Lehman was a symptom as well as a cause of the recent crisis and, second, the Fed and the Treasury simply had no tools to address both Lehman and the other companies that were under stress at that time. I think that criticism is appropriate, though, as directed toward the United States as a whole. We did not have—as the Europeans have or as we have FDICIA for banks—a system that was set up to allow a reasonable and responsible orderly resolution of nonbank systemically critical institutions. I think we now have made a lot of progress there. The TARP will provide a good interim solution. It is very important that in the future we address the too-big-to-fail problem that we have, that we find ways to reduce that problem, and that we find ways to deal systematically with firms that are in crisis. So given the fog of war—which has, of course, been intense going back for more than a year—I would defend what we’ve done in terms of the general direction, acknowledging that execution is not always perfect and that communication is not always perfect.
Now, what about the future? History suggests that, whenever a financial crisis becomes sufficiently severe, ultimately the only solution is a fiscal solution, and we will have a fiscal solution. There are two possibilities. One is that the financial system will muddle through, in which case the fiscal solution will be of the sort we’ve already seen: injections of capital, support for critical firms, support for the credit markets in general; Keynesian-style demand support. That’s one possibility. I hope that’s where we’re going to be. In my own testimony, I argued that we should try to focus whatever stimulus we have in solving the underlying problems rather than simply handing out money and that we could do that, again, by addressing credit markets. I would add, foreclosure, homeownership, and some of those issues as well. So I hope that’s where the fiscal policy will be. I hope that will take the lead from us going forward. Obviously, we’ll have to continue to play a supporting role in a lot of different ways.
The other possibility, of course, is that things get much worse and that we are in the same situation as Sweden or Japan, in which case a massive recapitalization of the banking system will be necessary. That will eventually happen, but I just note that, in all of these fiscal dynamics, there is a political economy overlay. You have to get to the point that it is not only the right policy to induce fiscal support but also that it is politically possible. That’s one reason that I think the TARP was not possible before the most recent period. In fact, it was barely possible recently. So, again, I believe that fiscal policy will have to be a critical part of the solution going forward.
Another part that we should not forget about is the international response, which is now just beginning really to become serious. The responses after the G7 weekend on banks and bank guarantees were important and suggested a commitment by other countries to stabilize the system. That’s very important. I think we will see aggressive monetary policy going forward, and I think we’ll see increasingly aggressive fiscal policy in other countries because they recognize that the decoupling is no longer a realistic story. So that’s going to be important as well.
With respect to the Federal Reserve, just generally speaking—and I’ll come back to the specific recommendation for today—again, I think that our liquidity provision has been constructive. It has allowed the use of our balance sheet to help push in the deleveraging process that’s been going on now for more than a year. My guess is it will probably expand some more, but I don’t see it expanding a lot more, if for no other reason than we are reaching the limits of our operational capacity as well as balance sheet capacity. I think we have been reasonably successful in staying on the side of liquidity provision and not straying into credit or taking credit risk. I want to stay on that side of the line both for legal reasons and because that’s the way monetary policy and lender-of-last-resort policy are supposed to work. Again, I hope that the fiscal interventions will now be able to take away some of these responsibilities from us, but we’ll have to see how they play out.
I confess that I hear President Plosser’s concerns about reversing these programs. I recognize that it’s something we’ll have to do carefully. But I just don’t see it as being something that will be a huge problem if the economy begins to recover and credit markets begin to function more normally. I think we’ll be able to do it. Japan was able to get out the quantitative easing without too much difficulty. But I acknowledge the point that it is something we’re going to have to plan for and think about.
On monetary policy, I think it is important for us to be responsive. Even if we stipulate for the moment that the interest rate changes we might make today have a minimal effect on the cost of capital—and I don’t necessarily agree with that, but let me stipulate it—there is still the importance of the signaling and what we’re trying to tell the markets about what we plan to do in the future. Frankly, I don’t think that we should try to signal that we are going to stand pat, that we are reluctant or refuse to move lower. We have to be prepared to move as low as makes sense. By that I mean in part that there are institutional factors that affect the efficacy of monetary policy at very low interest rates. We’re all aware of that. I asked yesterday, and I’ll ask again, for the staff to go back to the 2003 work, to update it, and to think it through and help us understand what I would call the effective zero. What is the real zero? Is it zero? Is it 50 basis points? Is it 75 basis points? We have to recognize that if we do go to literal zero, it would have very substantial effects on a number of financial markets, and we would have to ask ourselves whether the benefits from that are worth the dislocations. The Japanese thought they were, and for example, they did shut down the interbank market for a long time. Maybe doing it is worth that. Those are decisions that we need to make before the next meeting, and we will have opportunities to talk about this together and in public as well. But I do think that monetary policy needs to be proactive and to continue to be part of the solution here going forward.
What about today’s action? I essentially accept the general change in outlook as proposed by the Greenbook. Since our last meeting there has been an effective tightening in financial conditions, which has overwhelmed the 50 basis point cut that we did with the other central banks. The outlook has become much worse. So it is important for us to act aggressively and to signal essentially that we’re willing to do whatever is necessary to support the recovery of this economy. There has been a lot of talk about confidence. I think the best thing we can do for confidence is to say that we’re going to do whatever it takes, even if it involves extraordinary actions, to get this economy back onto a path where it can begin to grow in a reasonable way again. Signaling coyness, being cute, is not a safe strategy right now. We just need to be straightforward and say that we’re going to do what it takes. In my view, just to be specific, 50 basis points is the right step today.
Now, a number of concerns and objections have been raised. Let me address just a few of them. One is President Bullard’s very interesting presentation on the inflation trap, and intuitively it’s clear that, for a given real interest rate, you can have an equilibrium at which you have a high nominal rate and a high expected inflation rate or you can have a low nominal rate and deflation. Both of those things are possible. That was the trap that Japan got into. We obviously want to avoid the deflation trap. The question is, How do you avoid it? As far as I can see—obviously we can get further into this—the best two ways to avoid it are, first, as President Lacker suggested, reaffirm our commitment to price stability defined as 1½ to 2 percent or whatever our Committee’s general view is. We’re going to try to do that with our projections and potentially with the trial projection that we’re doing, and I think we can continue to strengthen our commitment to maintaining a positive inflation rate. The other thing, in terms of the dynamics, is to be aggressive in trying to avoid getting to a deflationary situation, where those expectations move in that direction. I don’t think deflation expectations will arise spontaneously because we’re cutting interest rates. I think they’ll arise because the economy is expected to be extremely weak, and anything we can do to eliminate that expectation in my view would be helpful.
The second objection I’ve heard is the question of whether or not these actions are effective. I think they are effective. Maybe they’re not as effective as under normal circumstances, but let me put it to you this way. If we cut 50 basis points today and the LIBOR–OIS spread rises 50 basis points tomorrow, I will accept that there’s a problem. But if the LIBOR spread doesn’t move much and the overall LIBOR drops 50 basis points, then I think that we’re having an effect. If you look at LIBOR over the past year, you’ll see a dramatic decline even though the spreads have widened. I don’t think you can argue that we’re not having any effect. To the extent that we’re having a muted effect, you can just as well argue that we should be more aggressive because you need to do more to get the same impact. So I understand those concerns, and I reiterate, responding to Governor Duke and others, that as we get very low, there are side effects on certain institutions and financial markets. We need to understand those, and that’s part of our decision process. But I don’t think it’s the case that monetary policy has zero impact.
The third argument I’ve heard is the “keep the power dry” argument. Unless you think that movements in the rate are entirely psychological in their effect, I don’t think that that’s a strong argument in this particular circumstance. Again, we analyzed this quite a bit in the 2003 episode, and the general outcome from the literature and from simulations done by our own staff—Dave Reifschneider, John Williams, and others have published research on this—is that the best way to avoid the zero bound is to be more aggressive than normal to try to avoid the accumulation of weakness and try to avoid getting into that trap. So more-preemptive strategies are, in fact, consistent with what we’ve done for the last year.
My recommendation for today is 50 basis points and the language in alternative A. I do think that it will be at least moderately beneficial both in terms of psychology and in terms of reducing the cost of funding and giving some additional support to funding markets. I hope that in these remarks, which again are somewhat extemporaneous, I have addressed to some extent the future steps. We ought, again, to think very hard in the next six weeks about what the real zero is and what the implications are of going below, say, 75 basis points. Then we ought to make a determination, and it may be that we can sit still in December. It may be that things improve quite a bit in the markets, for example. It’s possible. One advantage of doing 50 today is that we almost certainly will not have to do anything intermeeting because we will have done this significant step today. So in December we’ll be able to look at the situation. We may be able to do little or nothing—it is possible. But if we decide that further action is needed, at that point we should be prepared to decide what the regime is going to be, how far we’re going to go, and what the effective zero is, and I think that we shouldn’t hesitate to do that if that’s what the situation calls for. So I think there is a way forward. I understand the need to withdraw all these policy actions at an appropriate time. But I don’t think that focusing on the near term for the moment is at all inconsistent with the fact that at some point these things will have to be reversed. So, any further questions or comments? President Fisher.