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Fed Gov. Warsh: difficult work ahead for policymakers.

While the economy and financial markets are improving, stability is far from assured, Federal Reserve Gov. Kevin Warsh said in a recent speech.

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At the 12th annual International Banking Conference in Chicago in late September, Warsh cautioned that Fed policymakers face considerable work in an uncertain environment. He noted that the second anniversary of the financial crisis is no time to declare victory. Errors in removing accommodative monetary policy happen even in normal times, and "the current environment is anything but normal," he said.

Key questions remain to ponder

Warsh explored three major questions facing Fed policymakers: When should they remove the extraordinary policy accommodation instituted over the past couple of years? How might the policy response evolve? And how might U.S. monetary policy be affected by other macroeconomic policies?

Answering the first question, he said accommodative policy would be removed when conditions warrant. Divining that time is complicated by the unusually high level of banking system reserves and substantial liquid assets in the banking system, and the possibility that those two forces could trigger an "excessive surge in lending."

"In my view," Warsh said, "if policymakers insist on waiting until the level of real activity has plainly and substantially returned to normal--and the economy has returned to self-sustaining trend growth--they will almost certainly have waited too long."

New policies require consistent application

As to the second question about how the policy response will play out, he suggested that amid recovery the Fed might need to continue the "whatever it takes" approach it took to containing the financial crisis. "The asymmetric application of policy ultimately could cause the innovative policy approaches introduced in the past couple of years to lose their standing as valuable additions in the arsenal of central bankers," the governor remarked.

Finally, Warsh assured that the Fed and other monetary policymakers would closely monitor the moves of fiscal authorities around the world. "Monetary policy convergence has proven remarkable, and remarkably constructive, throughout the crisis," he said. "When the removal of accommodation begins in earnest, we should be alert to see if this trend continues."
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Publication:Financial Update
Date:Oct 1, 2009
Words:350
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