The danger of the Federal Reserve being out of “options” to boost the economy has been a recurring theme of commentators and scholars in the years during and after the Fed’s extended use of quantitative easing and low interest rates. The Fed began raising interest rates in December 2015 and is
But I propose that the Fed still has options it has not explored. There are three additional options for consideration that could help the Fed achieve its dual mandate and accelerate growth, each having to do with liquidity support that could be provided to banks through the discount window.
The discount window was originally conceived as the Fed’s fundamental way to regulate the flow of credit available in the banking system. It became more of a safety valve for banks with temporary funding shortages. Banks can obtain
Only certain types of bank assets are eligible for discounts or advances. Eligibility rules have continued to evolve over the years. Discount window advances were widely used when the discount rate was less than the federal funds rate, but since the 1980s, using the discount window has had a
Here are three additional liquidity-strengthening options.
Contingent liquidity facility
To make greater use of the discount window under current rules, William Nelson of The Clearing House recently
The facility would work as follows: In order to recognize the potential discount window borrowing ability of the banks, the Fed would establish, on demand, a contingency funding account for a bank and “advance into that fund, as discount window borrowing,” half the value of the assets pledged as collateral. That amount would then count toward their HQLA requirement under the Liquidity Coverage Ratio (LCR) regulations. Banks could thereby shift a portion of what they usually put into “deposits at the Fed, government securities, and securities issued by government supported entities” for meeting their HQLA requirement into loans to businesses and households.
But just how much more credit would banks be able to extend to the nonfinancial sectors of the economy? Nelson estimates an increase of over $1.1 trillion, or 15%, raising GDP by up to 0.75%. Banks would be permitted to meet a quarter of their HQLA requirement through the facility; that is $800 billion less HQLA the banks would need to obtain by buying government securities.
Expanding Fed liquidity support to longer-term business loans
A more ambitious method to increase loans to businesses and industries is to modify the type and maturity of assets acceptable for discounts at the discount window to include long-term loans to business and industry. This is a discounting power not utilized since the 1950s that could be revived and redesigned for today’s circumstances.
The original restrictions on the types of assets the Fed could discount contributed to the failures of banks in the 1930s and deepening the effects of the Great Depression. Beginning in 1932, Congress took aim at liberalizing what types of assets the Fed could discount for banks to unfreeze the banking system and speed the recovery.
In 1934, a shortage of working-capital loans being made to businesses and industries prompted
I am not proposing allowing the Fed to make direct loans to businesses, which would not find favor today, but a more modest revival of its power to discount these types of loans should be considered. A Fed backstop of this kind for banks could trigger more business and industrial loans, spurring long-term growth and creating more dependable and high-paying jobs. Congress would have to authorize it since the Fed cannot currently
Given the unconventional monetary policy and historic financial legislation of the last decade, this discounting option is not so radical. To put it in context, the Fed could decide to simply take these loans onto its balance sheet like it did for other types of debt under its quantitative-easing policy.
Federal Reserve Loan guarantee program for banks
A third option is for the Fed to establish a facility to provide loan guarantees for banks based on the central bank’s surplus.
During World War II, the Fed served as
After the government war guarantee program ended, some
There are many government agency loan guarantee programs today, including the Small Business Administration’s 7(a) loan
But Fed loan guarantees for businesses and industries may be more efficient than those made through other government agencies, since the central bank may be more attuned to loan demand. It is worth exploring whether the Fed’s surplus could be safely used to encourage banks to increase their loans to business and industry with guarantees.
Discount window proposals like those described above could help shape economic growth and are worth consideration.