Abstract
While the Federal Reserve is in the midst of a battle confronting it with a stark tradeoff between balancing unemployment and inflation, we have been thrust into a new debate about the effects of the policy implications of rising interest rates on the stability of banks. Certainly, our present situation will trace a path which is dependent on past policy decisions or hysteresis, the lag between input and output in a system upon a change in direction. This is particularly important in the consequences of the financial crisis and the new policy tools implemented to revive economic activity. And of course, we need to factor in the economic turmoil associated with the COVID crisis and market disruptions from the Ukrainian war.
While Bernanke’s book stops short of the COVID crisis, the coverage of the role of monetary policy in handling the financial crisis and the long-term fragile recovery from that disaster gives broad insights into the central role of the guidance offered by the Federal Reserve. Bernanke was the captain of a ship on tumultuous waters and held the responsibility of directing the usage of alternative policy tools in a volatile environment buffeted by multi-speed and multi-directional forces.
The overview of Bernanke’s assessment of the performance of the Federal Reserve under his leadership is that with the cooperation of the Treasury and legislative approval of vast funding, the financial crisis was contained by a collection of emergency measures and liquidity injections to stave off a looming much larger depression. Then in the post-rescue period, the Federal Reserve developed and implemented the use of a range of new policy tools to keep the pulse of the economy going.
The book lays out a comprehensive analysis of the Federal Reserve’s basic new policy toolkit. The expansion of the Federal Reserve’s balance sheet from the practice of implementing quantitative easing (QE) is an instrument shared with other advanced central banks including most prominently the Bank of Japan, the Bank of England, and the European Central Bank. QE has expanded the targeting of interest rates into the longer-term segment of the yield curve by the massive purchase of outstanding government bonds. These purchases result in driving up bond prices which are inversely related to bond yields. At some point, the tremendous increase in bond holdings will need to be reversed either by the gradual process of the maturing of the bonds or implementing the quicker practice of quantitative tightening, meaning selling off bonds prior to maturity.
There has also been a systematic change in the way the Federal Reserve influences short-term interest rates via setting returns in the market for exchanging bank reserves. In effect, the Federal Reserve adjusts two administered interest rates and thereby determines the bounds on the Federal Funds Rate (FFR) which now serves as the targeted rate. The upper bound is the interest on reserve balances (IORB) paid by the Federal Reserve and the lower bound is the rate on overnight reverse repurchase agreements (ONRRP) engaged by transactions with the Federal Reserve.
Major efforts have been invested in influencing the setting of financial market expectations via planned forward guidance tools. These tools have increased substantially the dissemination of information concerning the current and future planned direction of Federal Reserve policies in order to give substantially increased credibility to planning and implementation of current policy and future policy commitments. Excellent advanced introductory coverage and applications of these tools is a strength of the presentation, particularly with regard to how they work in unison to conditionally direct targets and produce results.
The presentation follows a historically directed narrative highlighting pressure points and responses to events during the financial crisis and over the long follow-up period during which the collection of new policy tools was introduced, refined, and adjusted to manage and correct the recovery path. Readers will need to consult other sources to provide a framework of the parallel work being undertaken by Congress and a number of administrative agencies to update and improve the regulatory structure for financial institutions and markets. There is also little discussion by Bernanke about the interplay and coordination efforts between fiscal and monetary policy. The book’s tight focus on monetary policy leaves out important strands of influence in the direction of the effective record of overall macroeconomic performance. And of course, as a personalized perspective from the former Chairman of the Federal Reserve, the book’s viewpoint is not comprehensive in presenting critical analysis of the policy directions and implementation chosen. It would be wise to consult other sources for opposing views of the effectiveness of the new monetary policy tools and any weaknesses in application.
While written for an informed general audience, professional economists will enjoy Bernanke’s defense in strong support for the independent role of the Federal Reserve and the treatment of the development of new monetary policy tools and approaches in meeting an extremely challenging period of economic crisis and extremely weak rebound. Undergraduate students in money and banking, financial markets, and intermediate macroeconomic courses would be wellserved to consult the book in order to gain a better appreciation for the role played by the contemporary Federal Reserve in the expansion of its macroeconomic policy framework.