2010 Articles

Comments on Ashcraft, Garleanu, and Pedersen, "Two Monetary Tools: Interest Rates and Haircuts"

Woodford, Michael

It is common to consider monetary policy as a unidimensional problem, involving only the choice of an operating target for some short-term interest rate (the federal funds rate, in the case of the Federal Reserve). But other aspects of policy have been at center stage much of the time in the Fed’s response to the recent financial crisis. In particular, whereas the Fed has traditionally adhered (at least to a large extent) to a policy of “Treasuries only” (Goodfriend 2011), under which the only asset on its balance sheet should be (mostly short-term) U.S. Treasury securities, the Fed has recently been involved in fairly large-scale extensions of credit to private institutions. These new programs have included “liquidity facilities” that extend (relatively short-term) credit to financial institutions of various types; facilities like the Term Asset-Backed Securities Loan Facility (TALF), discussed in this paper, that provide longer term financing for purchasers of privately issued financial assets, and thus effectively make the Fed a financial intermediary itself, rather than a mere supplier of liquidity to such intermediaries; and direct purchases of securities other than Treasuries, as in the case of the Commercial Paper Funding Facility (CPFF), which I discuss further below.

It is therefore an important question for the theory of monetary policy to consider to what extent these additional dimensions of policy serve additional purposes that could not already be achieved through traditional interest rate policy. There are actually two questions that need to be considered: first, whether such policies should be effective at all, in changing financial conditions; and second, to the extent that they are effective and whether they are simply substitutes for more aggressive use of interest rate policy. The present paper is one of the first to directly address these important questions; it provides cogent theoretical and empirical analyses of the first question, and an interesting theoretical argument with regard to the second question as well. Notably, the paper’s argument for the relevance of central bank “haircut policy,” even given the availability of traditional interest rate policy, does not turn on the observation that interest rate policy is sometimes (as in the United States since December 2008) constrained by the zero lower bound on nominal interest rates; this suggests the possibility of routine intervention along this dimension, rather than resorting to it only during especially severe crises (which are the only times that the zero lower bound is likely to be an issue).