The Federal Reserve’s near zero interest rate policy and $2 trillion dollar balance sheet have done much to stabilize economic and financial conditions in the United States. Yet the recovery from the Great Recession is slow. Net private job creation remains too low to absorb the secular growth in the labor force, let alone what is needed to return to work those who lost their jobs in the Great Recession.
We propose a specific reform of Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSEs) that securitize and guarantee conforming mortgages. Our plan protects taxpayers and the overall economy from the systemic risk posed by the former GSE model, while ensuring that financing remains available for housing even in periods of credit market strains. Under this proposal the two firms would become private companies that buy conforming mortgages and bundle them into securities that are eligible for government backing. The reformed firms would not have the investment portfolios that were the main source of risk under their previous structure. The federal government would offer a guarantee on mortgage-backed securities composed of conforming loans. This guarantee would be explicit, backed by the full faith and credit of the United States. To compensate taxpayers for taking on housing risk, Fannie and Freddie would pay an actuarially fair fee to the government in return for the guarantee, and the shareholders of the firms would take losses before the government guarantee kicks in. Other private firms such as bank subsidiaries would be allowed to compete by securitizing conforming loans and purchasing the government guarantee. Over time, entry into these activities would help ensure that the benefits of the government support are passed through to homeowners and would reduce the risk that the failure of any one firm would pose a threat to the housing market or the overall economy.
Independence has long been recognized as an essential element of effective central banking. The extraordinary central bank interventions in the recent credit turmoil precipitated a reconsideration of the nature of that independence. On one side, the Federal Reserve has been commended for its willingness to provide generous support for the financial system in lieu of congressional support that was not always forthcoming.
Monetary policy independence is often discussed, but almost never defined. What does it mean for a central bank like the Fed to be independent in the context of American political institutions? What is the point of its being independent? What threatens beneficial independence, and how should current reformers of financial regulation think about the likely consequences of increasing or decreasing the Fed’s regulatory powers or mandates on the Fed’s monetary independence?
In the present paper, McCallum argues that a crucial aspect of monetary policy is a systematic discrepancy in the times that elapse after policy actions before the observance of real and monetary effects. This discrepancy lends an inflationary bias toward policy efforts that is more pronounced, the more impatient is the policymaker. Finally, McCallum compares current monetary practices with those specified by the U.S. Constitution, and indicate how the intentions promoted by the Constitution could be fulfilled under today’s fiat money monetary
Monetary policy and fiscal policy serve different functions and have very different economic effects, but too frequently, their roles and effects are confused. Economic performance is best served when monetary and fiscal policy roles are clearly delineated. Now more than ever, with so many concerns about the economic recovery, jobs and mounting budget deficits, maintaining the Federal Reserve’s independence in the conduct of monetary policy and re-establishing the optimal boundaries between monetary and fiscal policies is critically important to sustained healthy economic performance.
Download the transcript of the Shadow Open Market Committee Symposium, which took place on March 26th in New York, NY. Read remarks from Federal Reserve Governor Kevin Warsh on the subject of central bank independence.
It was only just a few years ago that monetary policy experts had universally converged on a small set of central bank principles, Monetary Policy 1.0. These simple principles were based firmly on a central bank’s credibility and the trust the central bank inspired in businesses, households and financial market. However, some prominent economic policymakers now openly question some of the principles of Monetary Policy 1.0, and in turn wish to make a new, more fashionable Monetary Policy 2.0. We should all be concerned at this turn of events.
The Fed since its establishment in 1914 has had to struggle to maintain its independence from the Treasury and so recent experience must be viewed in historical context. The Federal Reserve Act gave the institution a considerable amount of independence from the fiscal authority. The Reserve banks could set their discount rates based on the demands by member banks to discount eligible paper. Government securities were not included in eligible paper so that the Fed, was not created to be a central bank to finance short run government revenue shortfalls.
Charles Calomiris examines Greece’s current and future fiscal affairs. Professor Calomiris concludes that it is unlikely that Greece will be forced to leave the euro zone this year, owing to the likely support of other euro zone countries (which its recent fiscal reforms likely have secured). But, he then lays out the case for why Greece – within only a few short years – is likely to leave the euro zone forever.
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