The Role and Worries of the Federal Reserve

Much of the burden of dealing with the current financial crisis has fallen on the Federal Reserve. If Treasury is not able to get approval for new programs and appropriations to fund them, the Fed may feel called upon to do even more if conditions do not improve.

The Fed, which cherishes its independence but realizes that it has limits, is clearly concerned that it may be getting into areas more properly labeled as fiscal policy. This appears to be what motivated a joint Fed/Treasury statement on March 23 -- "The Role of the Federal Reserve in Preserving Financial and Monetary Stability." This statement did not attract much attention since it was buried by other news.

The Federal Reserve clearly does not want to be in the credit allocation business and wants Treasury to take off its hands as soon as it can the "so-called [and opaque] Maiden Lane facilities." The statement also highlights the difficulty the Fed has had with both implementing monetary policy and dealing with the crisis, and it makes reference to the help the Treasury has provided the Fed in this regard with the Supplementary Financing Program. In addition, the statement mentions that Treasury and the Fed will ask for legislation "to provide additional tools the Federal Reserve can use to sterilize the effects of its lending or securities purchases on the supply of bank reserves." This probably means that the Fed wants to be able to issue its own securities, an idea that has some problems which I am sure will surface in Congressional hearings if pursued.

What this all shows is the continuing overlap in monetary and fiscal policy. The Treasury has been helping the Fed in monetary policy by borrowing funds it does not need, and the Fed has been using its ability to provide financial assistance to certain institutions and sectors of the economy because the Treasury does not have the resources to do it in a more accountable manner.