A program for strengthening the Federal Reserve's ability to fight the next recession

David Reifschneider and David Wilcox
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David Reifschneider: former Federal Reserve

No WP20-5, Working Paper Series from Peterson Institute for International Economics

Abstract: If the Federal Reserve does not decisively change the way it conducts monetary policy, it will probably not be capable of fighting recessions in the future as effectively as it fought them in the past. This reality helped motivate the Fed to undertake the policy framework review in which it is currently engaged. Researchers have suggested many steps the Fed could take to improve its recession-fighting ability; however, no consensus has emerged as to which of these steps would be both practical and maximally effective. This paper aims to fill that gap. It recommends that the Fed commit as soon as possible to a new approach for fighting recessions, involving two key elements. First, the Fed should commit that whenever it runs out of room to cut the federal funds rate further, it will leave the rate at its minimum level until the labor market recovers and inflation returns to 2 percent. Second, the Fed should commit that under the same circumstances, it will begin to purchase longer-term assets in volume and will continue such purchases until the labor market recovers. If the forces driving the next recession are not unusually severe, this framework might allow the Fed to be as effective at fighting that recession as it was in the past. If the next recession is more severe, however, the Fed will probably run out of ammunition even if it takes the two steps recommended here. Therefore, both monetary and fiscal policymakers should consider yet other steps they could take to enhance their ability to fight future recessions.

Keywords: Monetary policy; Federal Reserve; framework review; effective lower bound (search for similar items in EconPapers)
JEL-codes: E43 E44 E52 E58 (search for similar items in EconPapers)
Date: 2020-03
New Economics Papers: this item is included in nep-mac and nep-mon
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