|Fed Chairman Discusses Reasons for Recent Fed Actions
Tracing the events leading up to the economy's current condition, and the ways the Fed has responded to the economic challenges, Fed Chairman Ben Bernanke recently discussed the steps the Fed has taken and the role they play in fostering a recovery.
In Atlanta on April 14, Bernanke spoke at Morehouse College and addressed four broad questions concerning the Fed's actions and their intended consequences:
How did the economy reach this point? In answering this question, Bernanke acknowledged the complex causes and its global scope, but he pointed to the crisis in the subprime mortgage market as a chief cause of the unraveling of the worldwide credit boom. "Mortgage delinquencies and defaults rose, and the downturn in house prices intensified, trends that continue today," he said. "Investors, stunned by losses on assets they had believed to be safe, began to pull back from a wide range of credit market and financial institutions—reeling from severe losses on mortgages and other loans—cut back their lending," he said. These events combined to trigger a "remarkably rapid and deep contraction."
How is the Fed addressing the situation? Bernanke responded to this question by citing the Fed's twin mandates: maximum sustainable employment and stable prices. "However, given the ongoing problems in credit markets, conventional monetary policy alone is not adequate to provide all the support that the economy needs," he said. He cited the programs that have been created to create that support including short-term loans to banks, auctions of funds to financial institutions, and targeted lending outside the banking system. "The Federal Reserve will continue to take the necessary steps to unclog the credit markets and strengthen the economy," he said.
Does the Fed's response risk inflation down the road? While Bernanke described the Fed's approach as aggressive, he said that some have raised the question of whether these actions could ignite future inflation. "We have a number of effective tools that will allow us to drain excess liquidity and begin to raise rates at the appropriate time," he said. "That said, unwinding or scaling down some of our special lending programs will almost certainly have to be part of our strategy for reducing policy stimulus once recovery is underway."
Why did the Fed and the U.S. Treasury prevent the bankruptcy of some major financial firms? Bernanke said he was addressing this question because it has bearing on the steps that have to be taken if the United States is to avoid a similar crisis in the future. "As a general rule, my strong preference is that any firm that cannot meet its obligations should bear the consequences of the marketplace," he said. He cited the example of the financial services firm AIG, which avoided failure through government involvement, adding that this action "sets a bad precedent" but that preventing the failure of AIG was the "best of the very bad options available." He added that marketplace oversight needs overhauling. "We must ensure that all types of financial institutions, especially large and interconnected ones like AIG, receive strong and effective government oversight," he said, adding that regulators need a new set of procedures for dealing with large financial organizations on the brink of failure. "The Federal Reserve strongly supports such reform efforts," Bernanke said.