Federal Reserve & Interest Rates

The Federal Reserve held its third TAF today putting a $30 billion 28-day credit up for banks in need of liquid funds. This is a $10 billion increase from the initial Term Auction Facilities held in December. Winning bidders are to be notified tomorrow, January 15, 2008.

According to Fed Chairman Ben S. Bernanke, the TAF was introduced as a means of extending the discount window.  He stated that the intention of the TAF was to address the issues “affecting the interbank lending market without complicating the administration of reserves and the federal funds rate.”  Bernanke also stated that “TAF auctions will continue as long as necessary to address elevated pressures in short-term funding markets, and we will continue to work closely and cooperatively with other central banks to address market strains that could hamper the achievement of our broader economic objectives.”

Basically, the banks need the cash flow to increase their ability to lend to one another and to borrowers. If the cash flow is not there, the economy suffers a credit crunch, and that’s what the Fed is trying to prevent.  The TAF may become a permanent tool that the Federal Reserve will use in this regard, according to the Chairman.

Fed Governor Mishkin discussed his views on monetary policy in his speech Friday. He says that to reduce macroeconomic risks, “…First, timely action is crucial when an episode of financial instability becomes sufficiently severe to threaten the core macroeconomic objectives of the central bank… Second, policymakers should be prepared for decisive action in response to financial disruptions… Third, policy flexibility is crucial throughout the evolution of a financial market disruption.”

These elements in policy development are, in Mishkin’s view, the appropriate approach to macroeconomic turmoil similar to what our economy has been facing. He stressed that monetary policy is very much science and the variables of economic data are important factors in policy changes and the response in macroeconomic turmoil.