Martin Feldstein about the Fed’s unconventional monetary policy

03 November 2015

On 29 October, Martin Feldstein, Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research, gave a lecture in the CFS Presidential Lecture Series, following an invitation from CFS President Otmar Issing. Feldstein spoke about the Federal Reserve‘s (Fed) unconventional monetary policy measures after the 2007 financial crisis. He warned that those policies and the resulting extremely low interest rates could cause risks to financial stability in the future.

As the recession after 2007 was different from usual business cycle downturns, it could not be reversed by traditional monetary policy measures, Feldstein explained. Accordingly, the Fed’s attempt to curb the adverse consequences by lowering short-term interest rates failed and the crisis spread to Europe. Given the ineffectiveness of monetary policy, the U.S. government decided to implement a large fiscal stimulus program in 2009.

However, in Feldstein’s view, this program was not enough to generate a healthy recovery. The Fed then decided to introduce unconventional monetary policy measures, such as Quantitative Easing, and committed to keep short-term interest rates low for a considerable period of time. These measures worked very well and the economy recovered. However, Feldstein warned that the Fed’s unconventional monetary policy measures have caused a variety of risks in financial markets which could threaten financial stability when interest rates get back to normal. For example, the very low interest rates have induced investors and lenders to reach for yield by taking increased risks in their investing and lending decisions, Feldstein said. The increased risk taking has resulted in a mispricing of assets that could generate problems when the Fed normalizes interest rates.

Feldstein spoke in favor of a gradual and predictable rise in interest rates in the U.S. According to him, this will be more successful than a rapid and unanticipated rise. However, there is no guarantee that the adjustment will be smooth, he stated. Feldstein concluded that, during times of a severe crisis such as in 2007, a combination of revenue-neutral fiscal policy and traditional monetary policy measures is likely to work better than introducing unconventional monetary policies.