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The Current Economic Situation or How Did We Get Here? Fed Challenge 2008 Orientation Program Federal Reserve Bank of New York. Raymond Stone Stone & McCarthy Research Associates December 14, 2007. From October 31 FOMC Meeting. Too Easy for Too Long? (2003/2005).

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The Current Economic Situationor How Did We Get Here?Fed Challenge 2008Orientation ProgramFederal Reserve Bank of New York

Raymond Stone

Stone & McCarthy Research Associates

December 14, 2007










The Bloated Inventories of Both New and Existing Homes on the Market Put Downward Pressure on Home Prices


Fomc has maintained focus on mandated dual objectives
FOMC Has Maintained Focus on Mandated Dual Objectives the Market Put Downward Pressure on Home Prices

  • Maximum Sustainable Growth & Employment

  • Price Stability





Inflation issues for the fomc
Inflation Issues for the FOMC Can It Stay in This Zone?

  • The Persistence of High Energy Prices Risks Higher Core Inflation

  • Weak Dollar Has Been Associated With Sharp Gains in Import Prices

  • Food Prices Have Been Rising Quickly

  • The Key to Sustainable Price Stability is Well-Anchored “Inflationary Expectations”


Is the fed responsible for fueling speculative excesses in housing
Is the Fed Responsible for Fueling Speculative Excesses in Housing?

  • John Taylor (Taylor Rule) feels that the Fed kept rates too low for too long. Had the Fed followed the Taylor Rule during the 2003/2005 the housing boom and burst would have been more contained.

  • Both Greenspan and Bernanke regard the improbable but corrosive effects of the deflationary risks in 2003 as justification for taking the funds rate down to 1%, and for keeping rates low for a “considerable period”.

  • Greenspan and Bernanke note that long term rates failed to rise as the Fed began raising the funds target, and that this fostered stronger housing activity than otherwise.


So who is to blame
So Who Is To Blame? Housing?

  • Taylor blames the Fed for keeping rates too low for too long

  • Regulators should have been more proactive

  • Securitization of mortgages, shifting risk from direct lenders to a broad spectrum of investors

  • Rating Agencies

  • Risky mortgage instruments, and little discipline on the part of mortgage brokers

  • Naïve Public—”If a bank is willing to make me a loan, they must think I will be able to repay”


No Matter Who Is To Blame—The Resulting Credit Market Strains Represent Downside Risks to the Economy

  • Subprime related losses have diminished bank capital, and have rendered banks more restrictive in lending policies

  • Money market conditions have become strained increasing costs to borrowers

  • Credit market difficulties have turned borrowers away from the CP market, to banks, resulting in some unusual and potentially problematic issues for the inter-bank funding markets


Money market funds stopped buying abcp
Money Market Funds Stopped Buying ABCP Strains Represent Downside Risks to the Economy




Inter bank term funding costs have increased
Inter-Bank Term Funding Costs Have Increased Attempting to Fund this Demand


What has the fed done in response to these developments
What Has the Fed Done In Response to These Developments? Attempting to Fund this Demand

  • Provided Liquidity as needed via Open Market Operations

  • Extended term of discount window advances up to 30-days, and reduced the spread between the Discount Rate and Funds Rate Target to 50bps from 100 bps previously

  • Lowered the Funds Rate Target to contain the “real side” dislocations stemming from credit market turmoil.

  • Announced intentions to auction discount window credit to banks


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