Some of the unprecedented steps taken by the Federal Reserve in the aftermath of the financial crisis will likely stay in the central bank’s playbook, Chairman Ben Bernanke said Tuesday.
Lawmakers, particularly in the GOP, have heaped criticism on Bernanke and the Fed for taking unorthodox steps to try and pull the country out of a punishing recession. Many have questioned whether the bank’s efforts were counterproductive and encouraged inflation, citing the nation’s stubbornly high unemployment rate to make their case that the Fed’s policies haven’t worked.
But Bernanke said the Fed has learned a number of new policy tricks that could prove useful, even when good times return.
Many of the new tools “can be valuable even when the zero lower bound is not relevant,” Bernanke said, referencing rock-bottom interest rates, “and I expect to see increasing use of such tools in the future.”
Bernanke’s remarks at the Boston Fed’s annual conference came after two consecutive meetings in which a divided Fed board approved moves on monetary policy that do not have a proven track record.
In August, the Fed set an explicit timeline for keeping interest rates low, promising rates will be held near zero through the middle of 2013.
More controversially, the Fed in September announced “Operation Twist” — a balance-sheet reshuffling in which it will buy up long-term government securities while selling off short-term ones in an attempt to lower long-term borrowing rates.
That announcement was made shortly after GOP leaders in the House and Senate appealed directly to Bernanke to resist further attempts to boost the economy, arguing such steps would do more harm than good.
“The American people have reason to be skeptical of the Federal Reserve,” wrote the top two Republicans in both chambers.
On Tuesday, Bernanke said Operation Twist — as well as the controversial “quantitative easing” that was twice employed to drive down interest rates — will be “rarely used” in normal times. The moves were primarily taken because the Fed could lower interest rates no further, so when rates begin to rise they will not be needed, he added.
But other new techniques, such as increased explicit guidance about future moves and enhanced communications from central banks, could be here to stay. Some have called on the Fed to set explicit targets for things like inflation, which could further clarify the central bank’s moves.
The financial crisis has pushed to the forefront a responsibility that used to be seen, in Bernanke’s words, as the “junior partner to monetary policy” — maintaining the stability of the financial system.
Before the crisis, the Fed and other banks primarily concerned themselves with managing monetary policy, setting interest rates to address inflation and maximize employment.
But as the Fed and other banks were thrust into the role of lender of last resort, the vital role it plays in keeping the financial system liquid became apparent.
Bernanke cautioned that traditional monetary policy tools, such as setting interest rates, could be “too blunt” to deal with financial stability issues. He said those tools are best reserved to pursue macroeconomic goals, while more targeted tools will be needed to keep a financial system on solid ground.
But Bernanke conceded that assumption could be proven wrong.
“The effectiveness of such targeted policies in practice is not yet proven, so the possibility that monetary policy could be used directly to support financial stability goals, at least on the margin, should not be ruled out,” he said.