Besides the central bank may not have much

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as we are seeing now in mortgage markets. Besides, the central bank may not have much independence precisely when it is most necessary, such as in a severe financial crisis.
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86 The reforms that are required to address this predicament raise questions that go to the very roots of government involvement in finance and to what extent such involvement should be accorded a special status. But we think such reforms are necessary. We recommend that there be a pre-authorized standby authority -- e.g., a specially designated liquidity facility -- in the Treasury Department. This facility should be limited in scale and pre-funded by the government budget. It should support any market-wide purchases of securities by the Fed when an emergency need arises in a crisis. That is, the Fed will merely be the agent that is executing the liquidity support, but there will already be funding that is present for all of these purchases. This funding would buy back the collateral from the Fed within a pre- specified period: say, six to twelve months. The Fed cannot hold these assets on its balance sheet for long. Such an arrangement would mitigate the inevitable conflict between requiring quasi- fiscal actions by the central bank and securing its independence, while allowing for a timely crisis response. Unfortunately, nothing in the Dodd-Frank Act directly addresses the confounding of fiscal and monetary policy roles of the Fed that we have witnessed in continuing resolution of the crisis. 6.6. Summary In times like these, one cannot escape the thought that the Fed will ultimately have to inflate away government debt if the Treasury does not cut back soon on spending or raise taxes. In other words, rather than the Fed using its monetary policy toolkit to anchor inflation expectations, these will be set by the government’s debt or fiscal policy. The Fed will be printing money and setting interest rates to target the value of government debt. 46 When monetary policy and fiscal policy in the economy get so intertwined, what exactly is meant by the independence of the Fed? Most economists would, however, want the Fed’s decision-making powers to remain independent and focused on the economy’s long-term growth and price stability objectives. Bringing the GSE debt and risks explicitly into government budget planning will most likely lead to restrictions on their growth and reductions in the fiscal deficit. It would also make it more likely that the Fed’s monetary policy remains independent in the future. If needed, the Treasury should set up a separate and pre-funded “bad bank” for difficult GSE assets with the sole task of liquidating them over time in private markets.
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87 Given the Fed’s multiple roles in attempts to resolve the crisis, the Federal Reserve Governor Ben Bernanke has been calling on the Congress for an action plan on the reforms at least since February of 2010: "The sooner you get some clarity about where the ultimate objective is, the better." For now, the worry is that just like Fannie and Freddie, the Fed too is being asked – or required – by the government to perform too many roles, often conflicting ones. We know how this ended up for Fannie and Freddie. It should not happen to the Fed.
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