Among the programs in force is the direct purchase of agency (Fannie Mae, Freddie Mac, etc.) notes and mortgage-backed securities. These securities are directly linked to mortgage rates. Purchases began just a few days ago. The goal of such a program is not, in my view, to engineer a particular interest rate level, that is, to hit a particular rate target. But direct purchases can promote directionally lower rates, help restore normal market functioning, and thereby achieve a return to reliance on private sector market-based credit allocation.

The introduction of targeted asset-side measures has been aimed squarely at the breakdown of credit markets, the circulatory system of our modern economy. In my view, a precondition of economic recovery is the return of the normal functioning of credit markets.

The Federal Reserve has undertaken policy actions of historic proportion. We have aggressively cut the federal funds rate, our traditional policy lever. We have also created multiple new lending facilities and transformed the asset side of our balance sheet. And, going forward, we will be expanding nontraditional policies now that the fed funds rate is approximately zero. Accordingly, we are faced with the challenge of calibrating these unfamiliar policies and, in the future, determining the appropriate time and methods for winding them down.

Evans said that based on the outlook for rising unemployment, falling industrial production and a wider output gap, economic models suggest rates should be below zero.

"If it were not constrained by zero, those models would want to push it below zero, but that's not possible," Evans told reporters after a panel at the American Economic Association's meeting in San Francisco.

Quantitative easing, a way to flood the banking system with large amounts of money, "is a way to mimic below-zero rates and provide support to the economy," he said.

As reprted by Reuters.

You will note that the emphasis of our activities has been on expanding the asset side of our balance sheet—the left side, which registers the securities we hold, the loans we make, the value of our swap lines and the credit facilities we have created. We feel this is the correct side to emphasize. The right side of our balance sheet records our holdings of banks’ balances, Federal Reserve Bank notes or cash (currently over $830 billion) and U.S. Treasury balances.

When the Japanese economy went into the doldrums, the Bank of Japan emphasized the right side of its balance sheet by building up excess reserves and cash, only to find that accumulation did too little to rejuvenate the system.

As I said earlier, in times of crisis many feel that the best position to take is somewhere between cash and fetal. But it does the economy no good when creditors curl up in a ball and clutch their money. This only reinforces the widening of spreads between risk-free holdings and all-important private sector yields, further braking commercial activity whose lifeblood is access to affordable credit. We believe that emphasizing the asset side of the balance sheet will do more to improve the functioning of credit markets and restore the flow of finance to the private sector. In the parlance of central banking finance, I consider this a more qualitative approach to “quantitative easing.” It is bred of having learned from the experience of our Japanese counterparts.

Note that it will not be sufficient simply to roll back the current lending programs when the economy recovers. The precedents that have been set during this episode will influence how market participants expect policymakers to react during the next episode of financial market turmoil. Establishing a coherent and stable financial regulatory regime will require rolling back expectations about how the policymakers will respond to the next financial market disturbance. Rolling back those expectations will be impossible if moral hazard concerns are always set aside in the exigencies of a crisis.⁴

Indeed, a significant feature of the recent financial market stress is the strong demand for dollar funding not only in the United States, but also abroad. Many financial institutions outside the United States, especially in Europe, had substantially increased their dollar investments in recent years, including loans to nonbanks and purchases of asset-backed securities issued by U.S. residents.¹ Also, the continued prominent role of the dollar in international trade, foreign direct investment, and financial transactions contributes to dollar funding needs abroad. While some financial institutions outside the United States have relied on dollars acquired through their U.S. affiliates, many others relied on interbank and other wholesale markets to obtain dollars. As such, the recent sharp deterioration in conditions in funding markets left some participants outside the United States without adequate access to short-term dollar financing.

The emergence of dollar funding shortages around the globe has required a more internationally coordinated approach among central banks to the lender-of-last-resort function. The principal tool we have used is the currency swap line, which allows each collaborating central bank to draw down balances denominated in its foreign partner’s currency. The Federal Reserve has now established temporary swap lines with more than a dozen other central banks.² Many of these central banks have drawn on these lines and, using a variety of methods and facilities, have allocated these funds to meet the needs of institutions within their borders.³ Although funding needs during the current turmoil have been the most pronounced for dollars, they have arisen for other currencies as well. For example, the ECB has set up swap lines and repo facilities with the central banks of Denmark and Hungary to provide euro liquidity in those countries. The terms of many swap agreements have been adjusted with the changing needs for liquidity: The sizes of the swaps have increased, the types of collateral accepted by these central banks from financial institutions in their economies have been expanded, and the maturities at which these funds have been made available have been tailored to meeting the prevailing needs. Notably, in mid-October, the Federal Reserve eliminated limits on the sizes of its swap lines with the ECB, the Bank of England, the SNB, and the Bank of Japan so as to accommodate demands for U.S. dollar funding of any scale. Taken together, these actions have helped improve the distribution of liquidity around the globe.

This collaborative approach to the injection of liquidity reflects more than the global, multi-currency nature of funding difficulties. It also reflects the importance of relationships between central banks and the institutions they serve. Under swap agreements, the responsibility for allocating foreign-currency liquidity within a jurisdiction lies with the domestic central bank. This arrangement makes use of the fact that the domestic central bank is best positioned to understand the mechanics and special features of its own country’s financial and payments systems and, because of its existing relationships with domestic financial institutions, can best assess the strength of each institution and its needs for foreign-currency liquidity. The domestic central bank is also typically best informed about the quality of the collateral offered by potential borrowers.

This expansion of the scope and scale of Fed lending may not have been so large had we had better resolution mechanisms to deal with such failing firms as Bear Stearns and AIG. And perhaps our lending would not have become so wide-ranging had there been better regulation or more resiliency in the payment and settlement systems, including more transparency about the markets for mortgage-backed securities and credit default swaps.
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Some may think access to the Fed's lending facilities should be permanently expanded to include a wide range of financial institutions. I believe such expanded access to central bank credit would raise significant issues of moral hazard that would need to be addressed. And I have urged that we must continue to avoid compromising the Fed's independence — one of the great strengths of central banks.

Some people might think that expanding the Federal Reserve's regulatory and supervisory authority and giving it a sweeping mandate for financial stability would prevent the types of financial crises we have been experiencing this year. That is unrealistic.

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Going forward our focus should be on better regulation, not necessarily more regulation. We need to focus on ways to strengthen our financial markets to make market discipline more effective at mitigating systemic risk. We should think about which financial markets are critical to the efficient functioning of the payment system rather than focusing on individual firms. Ideally, we need to determine which aspects of the financial system are critical and then make sure we have the market mechanisms, regulations, and supervision to ensure those sectors are resilient.

We will need to decide the appropriate timing of the winding-down of many of the special lending facilities. The actions taken by the Federal Reserve to intervene directly in some financial markets, such as the commercial paper market, are clearly emergency operations only. Except in the most extreme circumstances, when market functioning breaks down and systemic risk reaches unacceptable levels, central banks should distance themselves from decisions about the allocation of credit among private parties.

One of the greatest of Federal Reserve chairmen, William McChesney Martin, once said that the job of the Fed is “to take away the punch bowl just as the party gets going.” As I speak to you today, we are in the midst of experiencing the consequences of the failure to take away the punch bowl and of allowing the exuberant “animal spirits” of our economy to get out of hand. We must never allow this to happen again.

You can see the size and breadth of the Fed’s efforts to counter the collapse of the credit mechanism in our balance sheet. At the beginning of this year, the assets on the books of the Fed totaled $960 billion. Today, our assets exceed $1.9 trillion. I would not be surprised to see them aggregate to $3 trillion—roughly 20 percent of GDP—by the time we ring in the New Year. The composition of our holdings has shifted considerably. Previously, almost 100 percent of our holdings were in the form of core holdings of U.S. Treasuries; today, less than a third are. The remainder consists of claims deriving from our new facilities.

By any measure, September was historic. The events of September contributed substantially to a fundamental restructuring of this country's financial system. It also brought a transition from an incremental approach, including the Federal Reserve's various measures to provide much-needed liquidity to markets, to a comprehensive attack on the diverse elements of the crisis.

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Looking ahead at the U.S. economy, this is a period of vexing uncertainty...With the deterioration in economic conditions and the recent associated falloff in energy and many other commodity prices, I anticipate further dissipation of inflationary pressures. Nevertheless, given high inflation readings during the summer and into the fall, I'll continue to watch developments closely.

We at the Atlanta Fed expect weakness to persist for some time into 2009 as credit markets gradually improve. The thawing of credit markets is a necessary condition for a recovery back to levels of growth consistent with the economy's underlying potential.

The Fed needs to be accountable for meeting its goals. Yet, we must take care to set reasonable expectations for what a central bank can achieve. We must recognize that over-promising can erode the credibility of a central bank's commitment to meet any of its goals, whether for monetary policy or financial stability.

Our preference is to allow market forces to handle any required restructuring in the financial services industry. However, in some cases this is not possible when the risks to financial stability are too high.

Regardless of our intentions, we need to recognize that by taking these actions, we create expectations about future interventions and who will have access to central bank lending. These expectations, in turn, can create moral hazard by influencing firms' risk management incentives and the types of financial contracts they write, which may ultimately increase the probability and severity of future financial crises.

Going forward, just as we should avoid setting unrealistic expectations for monetary policy, we should also avoid encouraging unrealistic expectations about what the Fed can do to combat financial instability. As I have argued, in times of financial crisis, a central bank should act as the lender of last resort by lending freely at a penalty rate against good collateral. Yet, recent experience suggests we need to clarify what the Fed can and cannot be expected to do in today's complex financial environment.

The events of the past year underscore the importance of carefully assessing the current financial regulatory structure. Regulatory reforms should aim to lower the chances of financial crisis in the first place, for example, by setting capital and liquidity standards that encourage firms to appropriately manage risk. We should consider market structures, clearing mechanisms, and resolution procedures that will reduce the systemic fallout from failures of financial firms. Indeed, it would be desirable to be in an environment where no firm was too big, or too interconnected, to fail.

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I believe that the central bank should clearly state objectives and set boundaries for its lending that it can credibly commit to follow. Clarifying the criteria on which the central bank will intervene in markets or extend its credit facilities is not only essential but critical.

Let me say that looking only at the Federal Funds rate during periods of significant economic headwinds will, in my view, provide a misleading gauge of the degree of monetary stimulus that the Federal Reserve has put in place.  At such times, a low Federal Funds rate does not signal a particularly accommodative monetary policy, but rather offsets some of the contraction that would otherwise occur as financial institutions tighten credit standards and offer borrowing rates with a spread over the Federal Funds rate that is larger than usual (in other words, larger than would be the case outside of credit crunch conditions).

That said, make no mistake: in my view, credit conditions would likely be much worse if the Federal Reserve had not lowered the Federal Funds rate and taken several innovative steps to enhance liquidity in the marketplace – steps like opening our new Term Auction Facility and other facilities that complement our traditional “Discount Window” for banks.

Unless the python that is the U.S. economy can quickly pass the recent burst of cost-push pressures, we risk a reinforcing spreading of inflationary impulses and expectations. Should this happen and the Fed were to fail to address it, we would run the risk of losing the public’s confidence in our ability to constrain inflation. Then the great editorial writers in this country, to say nothing of Congress and the American people, will be calling for all of us—doves and hawks alike—to be shot (metaphorically speaking, of course).