NEW YORK – Systematic “rule-like” approaches should be implemented in bad times and good times, Federal Reserve Bank of Philadelphia President Charles I. Plosser said.
“Good policy — and by that I mean policy that is clearly defined and systematically followed — should apply in good times as well as in tough times,” Plosser said in a speech at Stanford University late Tuesday, according to prepared text released by the Fed. “I do not mean that policy actions should necessarily be the same in both good and bad economic times. Yet, in each environment, we should conduct policy in a systematic way, one that is consistent, transparent, and largely predictable.”
This does not mean that policymakers can predict the future or what policy decisions will be, since the Fed reacts to data. “This means that future policy actions are conditional on how the economic data unfold — because the data inform our economic outlook,” he said. “The incoming economic data should feed into a decision-making process in a mostly systematic way.”
Part of the problem is there haven’t been many financial crises of this magnitude, so policymakers have little experience in this area. “As events moved quickly, we ended up learning as we went,” Plosser noted. “So it is probably not surprising that policy reactions appeared, at times, erratic, rather than systematic. Yet, in the process, we have learned that not having a clearly communicated systematic approach to our lending that covers bad — and really bad — times can be very confusing to the public and the markets.”
The reaction to the handling of the Bear Stearns, Lehman Brothers, and AIG woes, he said, exemplifies his point. “The lack of a clearly understood approach to the government's and the Fed's decisions about when assistance efforts would be provided created confusion and uncertainty.”
Having an explicit resolution mechanism for the orderly failure of a systemically important nonbank financial firm would have helped, and none exist. “The lack of a well-articulated systematic approach to the Fed's lending role contributed to uncertainty in financial markets about who would be ‘rescued’ and who would not,” he said. “That uncertainty still remains and must be one of the prime objectives of policy reforms going forward.”
Plosser reiterated his belief that no firm should be too big to fail, but the Fed shouldn’t be the authority that decides.
“In hindsight, a basic problem was that, in our desire to get financial markets working again, we offered no systematic view as to how and where the Fed would intervene — we lacked a well-communicated systematic approach,” he said. “Moreover, to my way of thinking, we strayed into credit allocation that, in my view, should be the purview of fiscal authorities and not the central bank.”
The conditions under which the Fed would serve as a lender of last resort must be clearly stated, he urged. “This policy should be systematic and should apply to both good times and bad. It should have clear, realistic, and feasible objectives; it should be consistent, transparent, and predictable; and it should operate independently of interest group pressures to lend to specific sectors or industries.”
While creating a systematic approach won’t be easy, nor will sticking to it, Plosser said, “Nevertheless, that is what we must tackle if we are going to achieve better results the next time a crisis arises.”
