Frederick Mishkin Further Discusses the Current Financial Instability and Monetary Policy
Today at the Risk USA 2007 conference Fredrick Mishkin spoke further about the current financial instability and general monetary policy. Much of the meeting this morning went on like his last speech given at the Museum of American Finance on October 22nd.
As before he opened stating that much of the issues that we are currently dealing with is derived from asymmetric information. By this he means that one person in the transaction (in this case the lender) has much less accurate information about the outcome of an investment than does the other party (in this case the borrower.) This when coupled with adverse selection, which is when investments that are most likely to produce an adverse outcome are most likely to be financed. As well as moral hazard, where the borrower has incentives to invest in high-risk projects, in which the borrower does very well if the project succeeds but the lender bears most of the loss if it does not.
The main difference from this meeting and the previous one is that he further discussed the Federal Reserve’s recent decisions. Stating that the September 18th 50 basis point rate cut was based off of the macroeconomic risk there was in regards to the tighter financial conditions on the economic outlook. Had they not eased policy, it would have faced a risk that the tightening of credit conditions had an intensifying housing correction would lead to much weaker output and employment, as well as worsening of the credit market. He also stated that the results of the half point change in September were very encouraging. The financial market functionality improved after the decision was announced. This outcome partially alleviated the risks of a coming credit crunch, however conditions in several markets remained strained.
During the last FOMC meeting in October where the funds rate was lowered by another 25 basis points on the 31st. This all came despite the gross domestic product results for the third quarter came in at a shocking increase of 3.9 percent. Mishkin stated today that dispite this the pace of economic expansion is expected to slow in the near term, largely because of the intensification of the housing correction.
Mishkin ended the meeting stating that he thinks the policy easing the FOMC put in place at the last two meetings significantly reduced the downside risks to growth s that those risks are now balanced by the upside risks to inflation. Also that the Federal Reserve will continue to act on their dual objectives of price stability and sustainable economic growth.
To read Frederick S. Mishkin’s speech about financial instability and monetary policy in full head on over to the Federal Reserve.