Even as the Federal Reserve moves to stem the recent turmoil in the financial markets, Federal Reserve Bank of Philadelphia president Charles I. Plosser warned not to expect the Fed to do things it can’t.
“I think it is particularly important, for example, to recognize that monetary policy cannot solve all the problems the economy and financial system now face,” Plosser said in prepared text of a speech delivered Friday at the Global Interdependence Center’s annual monetary and trade conference. “It cannot solve the bad debt problems in the mortgage market. It cannot re-price the risks of securities backed by subprime loans. It cannot solve the problems faced by those financial firms at risk of being given lower ratings by rating agencies because some of their assets are now worth much less than previously thought. The markets will have to solve these problems, as indeed they will. But it will take some time.”
The public perception of monetary policy’s capabilities has increased, according to Plosser.
“Indeed, there seems to be a view that monetary policy is the solution to most, if not all, economic ills,” he said. “Not only is this not true, it is a dangerous misconception and runs the risk of setting up expectations that monetary policy can achieve objectives it cannot attain. To ensure the credibility of monetary policy, we should never ask monetary policy to do more than it can do.”
While the Fed has taken a multi-pronged approach and addressed specific problems in the markets, “a myriad of questions” remain, Plosser said. “The answers are neither easy nor obvious, and we must be careful in our approach to solutions to avoid creating more problems than we solve,” he said. “A critical element of any solution rests in the ability to communicate effectively the underlying objectives of policy choices and the means by which we will achieve them. No easy task to be sure, but I am confident that we can meet this challenge to promote an efficient and effective environment for continued prosperity.”