The statement the Federal Reserve should publish ASAP

I have been asked about what the Federal Reserve should do in response to ‘corona shock’.

So here we go – I suggest the Federal Reserve immediately put out the following statement:

“The Federal Open Market Committee (FOMC) notes that the global shock from the spreading of the corona virus significantly has changed financial market expectations regarding the outlook for the US economy and particularly regarding financial and monetary conditions.

The FOMC also notes that financial market expectations regarding the outlook for nominal spending growth and inflation have deteriorated significantly and to such a degree that the US economy risks entering a potentially severe recession in the coming quarters and that there is a serious risk that inflation will further undershoot the Federal Reserve’s 2% inflation in the medium-term.

Consequently, the Federal Reserve will take imitate policy actions to ensure nominal stability and to avoid a recession.

First, of all the Federal Reserve will immediately undertake unlimited asset purchases in global bond, FX and commodity markets to ensure that market inflation expectations measured as TIPS inflation expectations (2, 5 and 10 year horizons) will permanently be in the range of 2-3%.

The policy is open-ended and permanent. Furthermore, the Federal Reserve will no longer try to ‘peg’ the Federal Funds rate. Rates will be determined by market forces.

Second, the FOMC wants to remind market participants that the Federal Reserve has the ability to expand the dollar money base unlimited to offset any increase in the demand for base money and to ensure hitting the 2% inflation target on any time horizon.

Third, the Federal Reserve will act in accordance with its mandate as a lender of last resort to the banking system and provide dollar liquidity to any financial institution domestic or foreign with proper collateral.

Fourth, the Federal Reserve is already in close contact with major central banks around the world to ensure that if necessary ample dollar liquidity is provided to the global financial system to avoid an unwarranted and disruptive hoarding of dollars. If necessary, the Federal Reserve will expand dollar-swap agreements with central banks around the world.  

Finally, the Federal Reserve is closely monitoring exchange rate developments, commodity prices as well as global inflation expectations so to stand ready to offset any potential negative shock to dollar-demand. The Federal Reserve will under no circumstances allow a potentially deflationary decline in money-velocity.

The Federal Reserve cannot mitigate the disruptions to the global supply chain resulting from the coronavirus, but the Federal Reserve will use all powers at its disposal to ensure that nominal stability is maintained.”

This is not my “optimal” policy proposal (that would include a NGDP target), but it is nonetheless what I believe to be the “right” policy given the Federal Reserve’s present policy framework.




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