As a result, the excess reserves wouldn’t be lent out; instead, the excess reserves would stay parked at the Fed. That said, the Fed’s exit from its current monetary policy stance is going to be more complicated than normal. Normally, when we exit, we simply decide when we are going to raise the federal funds rate target. This time, we have a broader set of decisions to make. For example, do we drain reserves from the banking system? Is it better for the banking system to operate with $ billion of excess reserves or $ trillion? This is an issue we have to explore further. In the meantime, we are testing our ability to drain reserves through the use of reverse repurchase agreements. It is important that this option be available to us in the event we want to use it. Although it is going to be more complicated in the sense that we have more decisions to make about how to manage our exit, I believe the process is manageable. The fact we have  BIS Review 161/2009  7  more levers doesn’t mean that we will have trouble exiting when the time comes, it just means that we will have more choices to make. Turning to the issue of the Federal Reserve’s monetary policy independence, I believe this is a critical issue. As you know, the Paul amendment, which was inserted into the House Financial Services bill, would subject the Federal Reserve’s monetary policy decisions to audit by the General Accountability Office (GAO).
Third, financial stability may be in danger when strong action by central banks during a crisis leads market participants to rely excessively on central banks as a backstop in case of negative shocks. This is the moral hazard problem.9 Taken together, these channels underline the risks the current “low-for-long”-situation presents for financial stability. These risks have to be acknowledged and acted upon. The fact that it is possible for these risks to exist while monetary policy is responding appropriately to the macroeconomic situation perfectly illustrates the Tinbergen principle – the number of instruments must equal the number of policy goals.10 In the current environment, the interest rate cannot be the instrument of choice for addressing financial stability risks. The answer is to give more weight to what are known as macroprudential instruments implemented as a complement to, and along-side a monetary policy that remains firmly focused on price stability. These instruments directly target the risk-taking behaviour underlying financial stability risks. This is exactly the approach chosen in Switzerland with the activation of the countercyclical capital buffer. By forcing banks to build up additional capital in the current phase of strong credit growth, the regulators aim at improving the capacity of the banking system to bear losses in the event that the identified risks materialise, while also limiting the further build-up of these risks. Outlook We are now in a position to derive the implications of our analysis for the interest rate outlook.