There's lots to digest from the not-released-until-this-morning transcripts of Federal Reserve meetings and conference calls in 2008. The transcripts give us an inside look at the thinking of America's top central bankers when the financial crisis hit. (Binyamin Appelbaum for the NYT has a good story here.)
Below I've excerpted comments from Ben Bernanke on Oct. 7, 2008, pgs. 12-15. I picked this passage out of many because it shows how the Open Market Committee was thinking at a really key moment.
The Dow was on a 25 percent one-month crash as the Federal Reserve's Open Market Committee deliberated. The bankruptcy a month earlier of Lehman Bros., a major Wall Street firm, had shown everybody the problems in the financial markets were grave.
Bernanke and several other Fed officials were on a confernce call trying to decide whether to cut interset rates in concert with several other central banks around the world. Not everyone (St. Lous Fed representative Robert Rasche, for instance) agreed this was a good idea, and Bernanke tried to make the case.
Here's what he said. I hope to annotate this as the day goes by. I underlined some key parts, and then bracketed and bolded my notes.
CHAIRMAN BERNANKE. Thank you. Other questions? All right. If not, let me just say a few words. I will be brief. It’s more than obvious that we have an extraordinary situation. It is not a single market. It’s not like the 1987 stock market crash or the 1970 commercial paper crisis. Virtually all the markets—particularly the credit markets—are not functioning or are in extreme stress. It’s really an extraordinary situation, and I think everyone can agree that it’s creating enormous risks for the global economy.
What to do about it? The exchange we just had suggests that we may have disagreements about the benefits of liquidity provision. I personally think that it has been helpful. [Not 100% sure what "liquidity provision" means here, but I think it refers to the then small level of Fed purchases of mortgage-backed securities to keep the market liquid.] But I think we can agree that it is obviously not a panacea because, as the Vice Chairman points out, it doesn’t address the underlying capital issues. That suggests that the right solutions probably have a significant fiscal element to them. However, one feature of the last few days is how striking, how uncoordinated, and how erratic some of the fiscal approaches have been—particularly in Europe, where there has been a remarkable lack of coordination in the European Union. So the fiscal solutions are coming, but they’re not there yet, and it is going to be a while. We need greater clarity on those issues. We had a meeting today on the Treasury’s authority [to create TARP, the $700 billion financial industry rescue fund], and they are hoping in the next few weeks to begin to provide greater clarity, which will be very helpful. But I think that, if we can find some kind of bridge, it would be helpful, and that’s what this meeting is about.
Although the financial markets are the dramatic element of the situation, I think we can make a case for easing policy today on the macro outlook, as given by Larry and Nathan. I won’t go into detail. I think it’s fairly clear. You look first at inflation, and you see the remarkable decline in commodity prices, the appreciation of the dollar, and the decline in breakevens. The 10-year breakeven this morning was about 1.35. Of course, that could be a noisy indicator, but certainly it’s quite low. I would say that, in terms of activity and the relation to inflation, we don’t have to rely on any flat Phillips curves here. [A flat Phillips curve would show that the relationship between inflation and aggressive monetary stimulus is muted, which was an argument against the hawkish view that extremely low interest rates could quickly lead to inflation. Inflation was a big fear on the Fed's Open Market Committee then, bigger probably than now. Bernanke is arguing here that the Fed could and should make interest rates even lower, and shouldn't worry about inflation unless it started to rear its head.] We have a global slowdown, and the implications for commodity prices are first order for our inflation forecast. It is never safe to declare inflation under complete control, and I certainly don’t claim that no risks are there; but clearly the outlook for inflation is not looking nearly so threatening as it may have in the past. [He continues to be right about this. Inflation is still at historically low levels.]
On the economic growth side, what is particularly worrisome to me is that, before this latest upsurge in financial stress, we had already seen deceleration in growth, including the declines, for example, in consumer spending. Everyone I know who has looked at it—outside forecasters and the Greenbook producers here at the Board—believes that the financial stress we are seeing now is going to have a significant additional effect on growth. Larry gave some estimates of unemployment above 7 percent for a couple of years. [Conservative estimate, it turns out. Unemployment hit 10 percent.] So even putting aside the extraordinary conditions in financial markets, I think the macro outlook [the overall economic outlook, he means] has shifted decisively toward output risks [the risks of a slowing or contracting economy] and away from inflation risks, and on that basis, I think that a policy move [to further lower interest rates] is justified.
I should say that this comes as a surprise to me. I very much expected that we could stay at 2 percent for a long time, and then when the economy began to recover, we could begin to normalize interest rates. [The 2 percent here is the interbank interest rate. It was 1.81 percent in September 2008. After the Oct. 7 meeting it dropped to under 1 percent, and then fell to under a quarter of a percent and has stayed that low ever since.] But clearly things have gone off in a direction that is quite worrisome. One could legitimately ask questions about the transmission mechanism under these conditions, and I think those are good questions. [Not sure what the transmission mechanism refers to, but maybe it's just the nuts and bolts of doing monetary stimulus? If anybody knows, let me know.] But first it seems to me that we can, to some extent, offset costs of credit through our actions, even if spreads are wide. Second, to the extent that the global coordination creates some more optimism about the future of the global economy, we may see some improvements in credit spreads. We may not, but it seems to me that this is the right direction in which to go. [This is the basic argument that also drives quantitative easing, that if the Fed can push lending rates down further, it will to some extent stimulate economic activity.]
Despite everything that’s happening, I might not be bringing this to you at this point, except that we have the opportunity to move jointly with five other major central banks, and I think the coordination and cooperation is a very important element of this proposal. First of all, again, I mentioned before the lurching and the lack of coordination among fiscal authorities and other governments. I think it would be extraordinarily helpful to confidence to show that the world central banks are working closely together, have a similar view of global economic conditions, and are willing to take strong actions to address those conditions. I think that there is a multiplier effect, if you will. Our move, along with these other moves, will have a stronger effect on the global economy and on the U.S. economy than our acting alone. Moving together has other benefits. Just to note one, we can have less concern about the dollar if we’re all moving together and less concern about inflation expectations given that all the banks are moving and all see the same problem.
There is a tactical issue. I think the real key to this is actually the European Central Bank. They have had some difficulty coming to the realization that Europe would be under a great deal of stress and was not going to be decoupled from the United States. They made an important rhetorical step at their last meeting to open the way for a potential cut, but I think that this coordinated action gives them an opportunity to get out of the corner into which they are somewhat painted and their move will have a big impact on global expectations about policy responsiveness. So, again, I think the coordination is a very important part of this.
I want to say once again that I don’t think that monetary policy is going to solve this problem. I don’t think liquidity policy is going to solve this problem. I think the only way out of this is fiscal and perhaps some regulatory and other related policies. But we don’t have that yet. We’re working toward that. We are in a very serious situation. So it seems to me that there is a case for moving now in an attempt to provide some reassurance—it may or may not do so—but in any case, to try to do what we can to make a bridge toward the broader approach to the crisis.
So that’s my recommendation, that we join the other central banks in a 50 basis point move before markets open tomorrow morning. [50 basis points is half a percent. A basis point is 1/100th of a percent.] If we proceed in that direction, there are, as I mentioned, two statements. Brian, do the Presidents have the joint statement?
You can read the whole transcript of the conference call here, and you can look at the minutes from Sept. 18, 2008, here. I hope to eventually have another blog post on then Minneapolis Fed Chairman Gary Stern's comments at that meeting.
(AP photo from Dec. 4, 2008, when Bernanke used to let his beard run more wild)