Prompt. In the last few weeks, the Federal Reserve hasintroduced a series of unconventional monetary policy tools—lendingfacilities, essentially, designed to ease credit strains that firmsand municipalities will likely experience as the U.S. economy isbuffeted by the novel coronavirus pandemic. The “Fed Brief” thataccompanies this prompt outlines these new unconventional tools.Section 13(3) of the Federal Reserve Act grants the central bankthe authority, with the approval of the Secretary of the Treasury,to implement these tools in emergency situations—what the Actidentifies as “unusual and exigent” circumstances.
The governors of the Federal Reserve reason that theseunconventional actions are in the best interest of the economy.Nevertheless, the governors are concerned that these actions, whichhave attracted the attention of journalists, politicians, andpundits alike, could ultimately politicize the Federal Reserve and,in doing so, compromise its ability to achieve its long-runmonetary policy goals. Consider, for example, the recent WallStreet Journal article, by renowned financial journalist Greg Ip,that accompanies this prompt. Thus, the governors—Michelle Bowman,Lael Brainard, Richard Clarida, Jerome Powell, and RandalQuarles—ask you to assess how the central bank’s recentunconventional actions might affect its monetary policy outcomes inthe long run. Specifically, the governors ask you to answer thefollowing three questions.

1. In general, would the politicization of the central bank rendermonetary policy more or less time consistent? Please defend yourreasoning.

2. Central banks endeavor to maintain time-consistent monetarypolicies, because time-inconsistent monetary policies tend todeliver unwanted inflation outcomes in the long run; why dotime-inconsistent monetary policies underperform in this way?

3. Finally, provide an example of how the Federal Reserve and,perhaps, Congress could preserve (or, if necessary, restore) thecredibility of the central bank’s commitment to maintain low andstable inflation. Again, please defend your reasoning.