Federal Reserve Efforts Io Improve the Economy's Performance

At the Federal Reserve, we are working hard--both as central bankers and as financial regulators--to help restore our nation's prosperity. In 2008 and early 2009, the world suffered the worst financial crisis since the Great Depression, a crisis which, had it been left unchecked, would have resulted in a global financial meltdown and an economic collapse. Working with policymakers around the world, the Federal Reserve acted creatively and forcefully to help stabilize the financial system and halt the economic slide. Our economy has been growing and adding jobs for more than two years now. But for a lot of people, I know, it doesn't feel like the recession ever ended. The unemployment rate remains painfully high, and more than two-fifths of the unemployed have been out of work for longer than six months, by far the highest ratio since World War II. These problems are very serious, and we at the Federal Reserve have been focusing intently on supporting job creation. Supporting job creation is half of our marching orders, so to speak; the other half is controlling inflation. Or, in the language of the law that sets the mandate for monetary policy, the Federal Reserve is required to seek both maximum employment and price stability.

We pursue those two important goals by influencing the level of interest rates and other financial conditions. My colleagues and I on the Federal Reserve's monetary policymaking committee equate price stability with inflation being at 2 percent or a little less. That rate is low enough that people and businesses can make financial decisions without having to worry too much about rising costs, but high enough to keep the economy away from deflation--falling wages and prices--which is both a cause and a symptom of an extremely weak economy. Although spikes in oil and food prices, and other transitory factors, pushed inflation up earlier this year, inflation appears to be moderating, and we expect, based on the best information that we have today, that it will remain reasonably close to our objective of 2 percent or a bit less for the foreseeable future.

In the longer term, monetary policy is the main determinant of inflation, and so Federal Reserve policymakers have considerable latitude to choose our longer-term inflation goal. In contrast, "maximum employment" depends on many factors outside of the Federal Reserve's control, such as the skills of the workforce and the pace of technological innovation. Right now, my colleagues on the Fed's policymaking committee estimate that the U.S. economy could sustain an unemployment rate of somewhere between 5 and 6 percent without generating a buildup of inflation pressures. But, regardless of whether the sustainable rate is 5 or 6 percent, with unemployment currently at 9 percent, our economy is certainly falling far short of maximum employment. That high unemployment rate is why the Federal Reserve is focusing its monetary policy at strengthening the recovery and job creation, including keeping short-term interest rates near zero and longer-term rates, such as mortgage rates, at the lowest levels in decades. Keeping borrowing costs very low supports consumer purchases of houses, cars, and other goods and services, as well as business investment in new equipment, software, and facilities. Over time, greater demand on the part of households and businesses leads to increased economic activity and employment.

Like other central banks around the world, one way in which we have put downward pressure on longer-term interest rates is by purchasing high-quality, longer-term securities in the open market--specifically, in our case, U.S. government securities and federally backed mortgage securities. It is important to understand that this type of activity isn't the same as government spending. We will sell the securities back into the market or simply allow them to mature as part of the process of tightening monetary policy when the economy improves. In the meantime, we earn interest on the securities we hold. In fact, the Federal Reserve's securities purchases and other actions during and after the crisis have had the side effect of reducing the federal budget deficit. Last year and the year before, we returned a total of $125 billion of those earnings to the U.S. Treasury, and payments to the Treasury in the current year will be substantial as well.

In addition to our monetary policy role, the Federal Reserve shares responsibility with other government agencies for regulating and supervising banks, protecting consumers in their financial dealings, and fostering financial stability. We're working with the other agencies to significantly increase the financial reserves that banks--especially the largest banks that can put the financial system at risk--must hold against possible losses. The Fed and the other agencies also are toughening the restrictions on the kinds of financial transactions that banks can undertake and working to ensure that bankers' compensation packages do not give them incentives to take excessive risks. We are requiring banks to compensate and assist foreclosed-upon homeowners who were unfairly treated. And, importantly, we are working to increase the resilience of the financial system as a whole against financial and economic shocks that may occur in the future. We are also collaborating with the Federal Deposit Insurance Corporation to implement new rules that will make it easier for the government to unwind big financial firms if they get into trouble, rather than being faced with the terrible choice of either bailing them out or risking the collapse of the financial system if they fail.

Of course, the Federal Reserve was never intended to shoulder the entire burden of promoting economic prosperity. Fostering healthy growth and job creation is a shared responsibility of all economic policymakers, in close cooperation with the private sector. Spending and tax policy is of critical importance, but a wide range of other policies--pertaining to labor markets, housing, trade, taxation, and regulation, for example--also have important roles to play.

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