This four-year project directed by Senior Scholar L. Randall Wray will explore alternative methods of providing a government safety net in times of financial crisis. In the present crisis, the United States has used two primary methods: a stimulus package approved and budgeted by Congress, and a huge, complex bailout by the Federal Reserve. The project will examine the benefits and drawbacks of each method, focusing on questions of accountability, democratic governance and transparency, and mission consistency. It will also explore the possibility of reforms that might place on Congress more responsibility for provision of a safety net, with a smaller role to be played by the Fed. This could not only enhance accountability but also allow the Fed to focus more closely on its proper mission.
The following issues in particular will be addressed:
- Is there an operational difference between commitments made by the Fed and those made by the Treasury? What are the linkages between the Fed’s balance sheet and the Treasury’s?
- Are there conflicts arising between the Fed’s responsibility for normal monetary policy operations and the need to operate a government safety net to deal with severe systemic crises?
- How much transparency and accountability should the Fed’s operations be exposed to? Are different levels of transparency and accountability appropriate for different kinds of operations—e.g., formulation of interest rate policy, oversight and regulation, resolving individual institutions, and rescuing an entire industry during a financial crisis?
- Should safety net operations during a crisis be subject to normal congressional oversight and budgeting? Should such operations be on or off budget? Should extensions of government guarantees (whether by the Fed or the Treasury) be subject to congressional approval?
- Is there any practical difference between Fed liabilities (banknotes and reserves) and Treasury liabilities (coins and bonds or bills)? If the Fed spends by “keystrokes” (crediting balance sheets, as Chairman Bernanke says), can or does the Treasury spend in the same manner?
- Is there a limit to the Fed’s ability to spend, lend, or guarantee? Is there a limit to the Treasury’s ability to spend, lend, or guarantee? If so, what are those limits? And what are the consequences of increasing Fed and Treasury liabilities?
- What can we learn from the successful resolution of the thrift crisis that might be applicable to the current crisis? Going forward, is there a better way to handle resolutions, putting in place a template for a government safety net to deal with systemic crises when they occur? (This is a separate question from the one regarding creation of a systemic regulator to attempt to prevent crises from occurring; however, we will explore the wisdom of separating the safety net’s operation from the operations of a systemic regulator.)
- What should be the main focuses of the government’s safety net? Possibilities include rescuing and preserving financial institutions versus resolving them, encouraging private lending versus relying on direct spending to create aggregate demand and jobs, providing debt relief versus protection of interests of financial institutions, and minimizing budgetary costs to government versus minimizing private or social costs.
- Does Fed intervention create a burden on future generations? Does Treasury funding create a burden on future generation? Is there an advantage of one type of funding over the other?
Since these issues were raised in the congressional debate of the 2010 Dodd-Frank financial reform bill without any major resolution, it is likely that the discussion will continue as the legislation implementing the new bill is formulated. A major goal of this project, therefore, is to provide a clear and unbiased analysis of the issues and thus a solid basis for that discussion, as well as a series of proposals on how the Federal Reserve could be reformed to offer more effective governance and more effective integration with both Treasury operations and congressional fiscal policy.