Jeffrey Lacker on the History of Fed Credit Policy and the Four Doctrines of Fed Lending

Episode Summary

Executive Summary: Jeffrey Lacker and David Beckworth examine the Shadow Open Market Committee’s role in shaping anti-inflation thinking, then focus on Lacker’s history of Fed credit policy: from classical lender-of-last-resort ideas aimed at monetary stability, to real bills, Warburg-style mercantilism, and modern too-big-to-fail/financial-systems-savior interventions. They also debate the Fed’s framework review and whether recent policy changes are improving or weakening credibility.

Main Topics: Shadow Open Market Committee and anti-inflation influence (Priority: 5/5): The conversation reviews SOMC’s founding in 1973 to challenge inflation, its role in public debates, and its influence on Volcker-era anti-inflation credibility and later Fed policy discussions. Fed framework review and inflation-targeting debate (Priority: 5/5): Beckworth raises Powell’s apparent signal that the Fed may return from flexible average inflation targeting to standard inflation targeting. Lacker gives a mixed assessment: the 2020 framework may have worsened the 2021 inflation mistake, but frequent wholesale framework changes could weaken long-run anchoring. Distinguishing monetary policy from credit policy (Priority: 5/5): Lacker defines monetary policy as changes in central bank liabilities via government securities operations, versus credit policy as lending to private borrowers or buying private assets, which has fiscal-like features and greater political risk. Historical doctrines of Fed lending (Priority: 5/5): Lacker traces four doctrines: monetary stability/lender of last resort, real bills, Warburg’s mercantilism, and too-big-to-fail. He argues these doctrines reflect distinct philosophies about what Fed credit should accomplish. Too big to fail and the expansion of the safety net (Priority: 5/5): The discussion emphasizes how post-1960s emergency lending and 2008 crisis actions expanded implicit guarantees, encouraged fragility, and broadened the financial safety net from banks to larger organizations and eventually to broader markets. Solutions: resolution planning and limiting emergency backstops (Priority: 4/5): Lacker argues for skepticism toward assumptions of inherent fragility and favors stronger living-will resolution regimes that do not rely on Fed or FDIC lending, to reduce bailout expectations and moral hazard.

Key Arguments: SOMC mattered because it pressed the view that the Federal Reserve—not outside forces—was responsible for controlling inflation, helping build support for Volcker’s disinflation. The 2020 FAIT framework’s tilt toward employment and willingness to overshoot may have contributed to the Fed’s delayed response to inflation in 2021. A credible framework should be quasi-constitutional and stable over time; frequent wholesale rewrites risk making it a reflection of current fashion rather than a long-run anchor. Monetary policy is about changing the supply of the Fed’s own liabilities through government securities operations; credit policy is lending to the private sector or buying private assets, which resembles fiscal action. Classical lender-of-last-resort doctrine was fundamentally about supplying elastic currency and stabilizing the money supply, not rescuing specific firms or sectors. The real bills doctrine was flawed because it tied money creation to nominal commercial-paper activity, was procyclical, and misread policy tightness during the Depression. Warburg’s advocacy for a central bank partly aimed to move trade finance to New York, foreshadowing later Fed concern with the health of money markets and the global dollar system. Too-big-to-fail interventions create moral hazard by implicitly guaranteeing large financial firms and encouraging them to rely more on short-term wholesale funding. Post-2007 Fed actions showed a discontinuous shift toward active credit-market support, signaling to banks that the Fed was willing to backstop them, which likely weakened incentives to raise capital before the crisis intensified. The best way to address too-big-to-fail is to strengthen credible resolution regimes so large firms can fail without public backstops or extraordinary Fed credit. The 2020 and 2023 episodes show the safety net continuing to expand, suggesting regulators respond to each crisis by pushing risk outward rather than shrinking guarantees.

Data Points: SOMC founding year: 1973 - Jeffrey Lacker explains that the Shadow Open Market Committee was founded in response to rising inflation. Fed discount window lending before August 2007: about $200 million at most per week, usually much less - Lacker contrasts normal pre-crisis lending with the post-2007 expansion. Discount window lending typical level before crisis: about $50 million per week - He notes that regular lending was generally tiny before the financial crisis. Fed/Treasury joint statement: spring 2009 - Lacker references the 2009 statement on the respective roles of the Fed and Treasury in financial stability and monetary policy. Fate framework adopted: 2020 - Beckworth and Lacker discuss the Fed’s flexible average inflation targeting regime introduced in 2020. Fed inflation-target framework codified: 2012 - Lacker says the Fed originally formalized what had effectively been a 2% inflation target in 2012. Helicopter drop size: about $5 trillion - Beckworth cites pandemic-era stimulus as a large nominal injection relative to GDP. Share of financial-sector debt viewed as guaranteed: 45% - Lacker cites research estimating the share of financial debt explicitly or implicitly backed by government support in 1999. Largest banks under post-2008 safety net: largest 12 banks - Lacker describes how the implicit safety net expanded after the crisis. SCAP banks: 18 or 19 banks - He mentions the Supervisory Capital Assessment Program as extending scrutiny and support to more large banks. Lehman Brothers equity subscriptions: $30 billion - Lacker cites investor demand during Lehman’s capital raise as evidence that more equity could have been raised. Lehman Brothers equity actually taken: $5 billion - He notes Lehman accepted only part of the available subscriptions. Discount-window borrowing during early crisis support effort: up to $7 billion - Lacker says the Fed’s 2007 effort to normalize discount-window use rose only briefly to this level. Federal Home Loan Bank borrowing increase: a couple of hundred billion - He contrasts this with much larger borrowing from the FHLBs in the second half of 2007.

Pivotal Quotes: "the base case was an ordinary reaction function where the Fed does not commit to overshooting in the future if they have undershot their target." — David Beckworth (quoting Powell): Beckworth describes Powell’s framework-review comment as a major signal that the Fed may move away from flexible average inflation targeting. "the point was to increase the supply of high-powered money to offset a decline in the money multiplier" — Jeffrey Lacker: Lacker explains the original lender-of-last-resort logic as monetary stabilization rather than targeted credit allocation. "we need to back, you know, really put that under a microscope and test that and maybe back away from that premise for intervention." — Jeffrey Lacker: He argues against assuming financial markets are inherently fragile and therefore always need central-bank rescue.

Implications: The episode argues for a more stable Fed framework, sharper limits on credit allocation, and stronger resolution planning to curb moral hazard. It also warns that each crisis has expanded the safety net, making future interventions and balance-sheet growth harder to resist.