Government Lending and Monetary Policy

The U.S. economy is now in the second year of a recession that began at the end of 2007.1 The deterioration in economic activity has been particularly sharp since September of last year. But throughout this downturn, a singular feature has been the extent of the disruption to financial markets and losses suffered by financial institutions. The financial dimension of this contraction has brought an historic expansion in government lending to financial market participants, mostly through an expanding array of Federal Reserve initiatives. In contrast, the Fed's response to most recessions in recent decades has been limited to adjustments of the target federal funds rate. We've done that in this cycle, too, bringing the funds rate target from 5 ¼ percent in September of 2007 to between zero and 25 basis points now. These two dimensions of the Fed's response are interconnected, since both involve the use of our balance sheet, but they have different impacts on the economy. So today, I'd like to speak about the economic effects of government lending and how that relates to our broader monetary policy goals. In doing so, I'll note what I see as important differences between monetary and credit policy and I’ll offer my thoughts on the Fed's role in the extension of government credit. And I'm sure you won't be surprised to hear that these are my own views and not necessarily those of any of my colleagues on the FOMC.