The Fed’s Dual Mandate Responsibilities: Maintaining Credibility during a Time of Immense Economic Challenges

Some interesting remarks on the current Fed policy delivered by the President if the Federal Reserve Bank of Chicago:

"I largely agree with economists such as Paul Krugman, Mike Woodford and others who see the economy as being in a liquidity trap: Short-term nominal interest rates are stuck near zero, even while desired saving still exceeds desired investment.

This situation is the natural result of the abundance of caution exercised by many households and businesses that still worry that they have inadequate buffers of assets to cushion against unexpected shocks. Such caution holds back spending below the levels of our productive capacity. For example, I regularly hear from business contacts that they do not want to risk hiring new workers until they actually see an uptick in demand for their products. Most businesses do not appear to be cutting back further at the moment, but they would rather sit on cash than take

the risk of further expansion.

(...)

Monetary economists often point to the poor economic experiences of the 1970s and 1930s as times when the Federal Reserve’s credibility account was debited substantially because of both of these factors. I believe the current liquidity trap environment following the 2008 financial crisis is similarly challenging today’s policymakers. So far, I believe we have done the right thing. Since the recession’s end in 2009, more than once the FOMC’s projections have proved too optimistic, and the U.S. economy has been unable to achieve escape velocity for returning to stronger, self-sustaining growth.

(...)

Rather than fighting the inflation ghosts of the 1970s, I am more worried about repeating the mistakes of the 1930s.

As in the 1930s, today we see a lack of demand for loans and a resistance of lenders to take on risk — factors that mean the high level of bank reserves is not finding its way into broader money measures. As in the 1930s, today’s low Treasury interest rates in good part reflect elevated demand for low-risk assets — we see investors run to U.S. Treasury markets every time they hear any bad economic news from anywhere in the world."