Financial Update (First Quarter 2009)

Lockhart: Policy Tools Remain in Federal Reserve's Arsenal

photo of Atlanta Fed Chairman Dennis Lockhart

The measures that the Federal Reserve has taken to right the economy should exert their corrective effects in 2009, said Dennis Lockhart, president and chief executive officer of the Federal Reserve Bank of Atlanta, in a January speech. He also said that even after all of its actions last year the Federal Reserve still has tools it can use if needed to support the economy and financial system.

In his remarks to the Rotary Club of Atlanta, Lockhart described economic conditions as extremely weak and financial markets as impaired. "In the banking sector, a posture of risk aversion—or at least caution—persists," he said.

Fed policy geared toward effecting recovery
Lockhart said that the Fed's policy moves—including lowering the fed funds rate close to zero—are aimed squarely at containing the impact of the economic downturn and stimulating a recovery as soon as possible. "The lowering of the funds rate target some 525 basis points since September 2007 can be seen as a direct response to worsening economic conditions and the resulting downward revisions to the outlook," he said.

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He also cited the Fed's focus on restoring health to the troubled financial sector, including credit markets, which Lockhart termed "the circulatory system of our modern economy." "A precondition of economic recovery is the return of the normal functioning of credit markets," he said.

Bernanke: Fed Will "Aggressively" Use Its Policy Tools

In remarks in London, Fed Chairman Ben Bernanke in January said that the Fed still has "powerful tools" at its disposal to combat the financial crisis and economic downturn, despite lowering the fed funds rate close to zero.

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More arrows in the quiver
Bernanke discussed three key tools the Fed has available as it works to right the economy: lending to financial institutions, providing liquidity directly to key credit markets, and buying longer-term securities.

"These three sets of policy tools?have the common feature that each represents a use of the asset side of the Fed's balance sheet, that is, they all involve lending or the purchase of securities," he said. "The virtue of these policies in the current context is that they allow the Federal Reserve to continue to push down interest rates and ease credit conditions in a range of markets, despite the fact that the federal funds rate is close to its zero lower bound."

Coordinated global policy actions needed
Bernanke also said that since the downturn is occurring on a global scale, the response must be conducted on the same scale. "The global economy will recover, but the timing and strength of the recovery are highly uncertain," he said. "Government policy responses around the world will be critical determinants of the speed and vigor of the recovery.

"International cooperation is thus essential if we are to address the crisis successfully and provide the basis for a healthy, sustained recovery," he said.

Room for more policy moves
Two new aspects of the Fed's recent policy approach—growth of the Fed's balance sheet and a change in the composition of the balance sheet's assets—drew emphasis from Lockhart, and he noted that these tools remain available to the Fed should the economic situation call for more action. "Even with the federal funds rate effectively at zero, there is ample scope to do more of both if conditions require," he said, noting that the U.S. Treasury also has implemented growth-oriented policies and that the new administration has proposed a fiscal stimulus.

Looking at 2009
In Lockhart's view, the U.S. economy will remain weak through at least the first half of 2009, but he anticipates the steps authorities have taken will begin to right the economy. "At some point—perhaps later this year—I believe financial markets will have stabilized sufficiently to support a recovery," he said. "To temper that a bit, there is always the risk of a shock or reversal in the financial sector or elsewhere that could again alter the outlook to the downside."


January 29, 2009