NEW YORK – Responding effectively and using innovation are key lessons learned from the recent financial crisis, Federal Reserve bank of Chicago President Charles L. Evans said today.
“As the crisis arose, we first used our traditional tools, substantially cutting the federal funds rate and lending to banks through our discount window. However, we lowered the funds rate to zero—as far as it can go—and still were facing frozen credit markets and severely deteriorating macroeconomic conditions. We thus turned to nontraditional tools to clear up the choke points,” Evans told the CFA Society of Chicago, according to prepared text of his remarks, which were released by the Fed.
The “nontraditional” tools allowed the U.S. to avert a “more severe economic contraction.”
Another lesson, Evans said he learned from the crisis, is “financial market supervision needs to be based on prospective economic conditions and applied at the same time across the range of institutions.”
Evans said the recession has ended, but “many households and businesses do not yet feel like they are in much of a recovery. Unemployment remains very high, and many businesses are still producing and selling much less than they did two years ago.”
While recovery will eventually return unemployment and other aspects of the economy to “more normal levels … but there is much work to be done.”
The housing market is mixed, consumer spending remains low, and unemployment is high, credit remains a problem. However, financial markets are performing better, without government support. “I expect banking conditions to improve, but this is likely to take some time,” Evans said.
The recovery will be modest, and inflation should be subdued, 1.5% or less in 2010 and 2011, before rising to 1.75% in 2012, he said.
“Monetary policy cannot be passive,” Evans said. “A large challenge facing policymakers over the next couple of years will be judging the appropriate timing and pace for reducing accommodation. On the one hand, removing too much accommodation prematurely could choke off the recovery. On the other hand, as I noted, if the Fed leaves the current level of accommodation in place too long, inflationary pressures will eventually build. The Fed is preparing for these decisions by carefully monitoring business activity and remaining alert for signs of incipient inflation. In addition, the FOMC is making sure that it has the technical tools it will need when it decides to reduce monetary accommodation. Overall, I am confident that monetary policy will bring and keep inflation near my guideline of 2% over the medium term.”
