Next steps for the Fed

Among the questions that the ongoing crisis in the U.S. Economy has raised is what tools, if any, the Federal Reserve can use in order to reduce unemployment and stimulate economic growth. In the past, this was done principally through the control of interest rates; yet a lengthy period of historically low rates has failed to end the economic crisis. So what, if anything, should the Fed do now?

Today's Wall Street Journal offers a sort of mini-symposium on this topic. Among the participants are Frederic Mishkin, a former governor on the Fed's board and author of Monetary Policy Strategy; and Ronald McKinnon, a fellow at the Stanford Institution for Economic Policy Research and author of Exchange Rates under the East Asian Dollar Standard and Dollar and Yen. Both focused on the Fed's recently announced strategy of purchasing long-term Treasury securities. Both seemed at least partially skeptical of the plan.

Mishkin:

Purchasing long-term Treasurys might suggest that the Fed is accommodating the fiscal authorities by monetizing the debt—thereby weakening the government's incentives to come to grips with our long-term fiscal problems. In addition, major holdings of long-term securities expose the Fed's balance sheet to potentially large losses if interest rates rise.

McKinnon:

But ultra-low interest rates will fail to stimulate the economy in the near term and the long term. In the near term, any increase in aggregate demand for investment or consumption from lower rates may well be offset by a supply-side constraint on bank credit expansion. In the longer term, near-zero interest rates will seriously impair important financial institutions such as defined-benefit pension plans.

RTWT here.