Ben Bernanke: I'm Warming Up the Helicopter!
The Fed Chair's talk today, January 10, 2008:
Ben Bernanke: Fortunately, after a number of years of strong earnings, most financial institutions entered the current episode in good financial condition. Thus, notwithstanding the effects of multi-billion dollar write-downs on the earnings and share prices of some large institutions, the banking system remains sound. Nevertheless, the market strains have been serious, and they continue to pose risks to the broader economy. The Federal Reserve accordingly has taken a number of steps... [along] two tracks: efforts to support market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy....
[O]n August 17, the Federal Reserve Board cut the discount rate--the rate at which it lends directly to banks--by 50 basis points, or 1/2 percentage point, and it has since maintained the spread between the federal funds rate and the discount rate at 50 basis points... facilitate the provision of discount window financing for as long as thirty days, renewable at the request of the borrower. Loans through the discount window differ from conventional open market operations... the loans can be made directly to individual banks... against a much wider range of collateral....
However... the discount window has... drawbacks... banks may be reluctant to use the window, fearing that markets will draw adverse inferences about their financial condition.... Second, to maintain the federal funds rate near its target, the Federal Reserve System’s open market desk must take into account the fact that loans through the discount window add reserves... the amounts that banks choose to borrow at the discount window can be difficult to predict, complicating the management of the federal funds rate....
To address the limitations of the discount window, the Federal Reserve recently introduced a term auction facility, or TAF, through which prespecified amounts of discount window credit can be auctioned... to provide a tool that could more effectively address the problems currently affecting the interbank lending market without complicating the administration of reserves and the federal funds rate.... [I]t appears that the TAF may have overcome the two drawbacks of the discount window.... The TAF may thus become a useful permanent addition to the Fed’s toolbox. TAF auctions will continue as long as necessary to address elevated pressures in short-term funding markets....
Although the TAF and other liquidity-related actions appear to have had some positive effects, such measures alone cannot fully address fundamental concerns about credit quality and valuation, nor do these actions relax the balance sheet constraints on financial institutions. Hence, they cannot eliminate the financial restraints affecting the broader economy....
Recently, however, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced.... Adverse economic or financial news has the potential to increase financial strains and to lead to further constraints on the supply of credit to households and businesses.... Thus far, inflation expectations appear to have remained reasonably well anchored.... However, any tendency of inflation expectations to become unmoored or for the Fed’s inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and reduce the central bank’s policy flexibility....
[W]e have brought the funds rate down by a percentage point from its level just before financial strains emerged. The Federal Reserve took these actions to help offset the restraint imposed by the tightening of credit conditions and the weakening of the housing market. However, in light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary... we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks... the Committee must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability.