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It’s important for the Fed’s authority to be ‘clearly in place’ throughout the pandemic: Former Fed Official

Former Fed Official and Peterson Institute for International Economics Senior Fellow David Wilcox joins Yahoo Finance Live to discuss the economic outlook into 2021.

Video Transcript

BRIAN CHEUNG: Welcome back to Yahoo Finance Live. And when we talk about economic stimulus, of course, you can get it from Congress, but you can also get it from the Federal Reserve. And with the news this morning, we know that fiscal stimulus, of course, is never a guarantee. There's a lot of moving parts there.

So let's talk about, on the other side of the coin, what can the Federal Reserve, the central bank, do in this type of situation as we head into 2021? Let's try to bring back in David Wilcox, the Senior Fellow at the Peterson Institute for International Economics, also formerly the head of research and statistics at the Fed. So David, I want to ask, you know, what can the Federal Reserve do in 2021, given that we know stimulus from the fiscal side of things is very hard to engineer? What types of tools does the Fed have at its disposal if economic conditions worsen?

DAVID WILCOX: At this point, Brian, the main tool the Fed has at its disposal is to make clear its determination to bring back the economy to a strong position. It'll clearly communicate that it intends to keep rates low, to continue buying bonds. And all of that will be really important for fostering aggregate demand and strengthen the overall economy.

We saw earlier, just in the last few days, a threat to another one of its authorities, its ability to put in place emergency programs. Fortunately, that threat was, by and large, turned back. Hopefully, we don't get back to the spot here in the next several months of needing to put any new emergency programs back in place. But it's important to have that authority clearly understood and solidly in place.

BRIAN CHEUNG: Well, David, you wrote a letter to the Federal Reserve in the end of November about how they should offer more forward guidance on quantitative easing, which they did in that December meeting, and build out their macroprudential tool kit. But it seems like maybe the call there is to be a bit more aggressive. The Federal Reserve appeared to be leaning into that with some of those emergency lending programs that you had mentioned to backstop things like the municipal bond market, corporate bonds.

But as we know, that was a very sharp political fight in Washington, DC over the current package about whether or not some of those emergency loan programs should be pared back, or even restricted, under a future Treasury secretary. What are your thoughts on that? Does that hobble the Federal Reserve's ability to combat the next crisis? Or is it not as big of a deal because it's just trying to preserve that independence?

DAVID WILCOX: It's an important question. A market meltdown, by and large, revolves around the question of confidence. And if you take away the Fed's ability to serve as a financial safety net of last resort, that could, in a moment of crisis, breed a lack of confidence. And that, in turn, could become a self-fulfilling promise-- prophecy.

So it's really important for the Fed's authority there to be clearly in place. The Fed has been very careful to stay within its lane in terms of its statutory authority. And so we need to have the ability of the Fed to step in when it's needed. After all, we've seen that authority exercised twice in the last dozen years.

ALEXIS CHRISTOFOROUS: The stimulus bill effectively does kill the municipal liquidity facility, as Brian was just saying. But it does still leave the Fed with an array of tools to combat a faltering economy in the new year, if they need to. I'm curious what you think the Fed could do to incentivize small rural banks to do more lending, because that's really been a sticking point up till now?

DAVID WILCOX: Better minds than mine will need to be applied to the question of what the new language just on the president's desk now awaiting his signature, what it does and doesn't say and how much it curtails the Fed's authority. I'm not sure I agree that it goes quite as far as you just suggested. But that will need to be tested. The language says they can't stand up the same programs as what were done under the CARES Act money.

How much will be required to make a program sufficiently different, that will need to be tested. The Fed may choose to be quite politically careful and conservative because historically, it's wanted to stay away from political disputes. In terms of incentivizing lending to small enterprises and from small rural banks, that really is not something that the Fed has great tools for doing. The Fed's main job is to get the overall economy going, and it doesn't have those kinds of surgical tools available to it.

ALEXIS CHRISTOFOROUS: If she is confirmed, which we expect her to be, Janet Yellen as our next Treasury secretary, she's going to have a hand in future Fed programs. And in the past, she's been pretty-- had a strong stance against Fed loan programs. Do you think she might be a little more liberal as Treasury secretary, a little less restrictive in that area?

DAVID WILCOX: Well, let's start with the fact that Janet Yellen is one of the most experienced economic policymakers in history. She's held key positions in the Fed and in the executive branch. So we can all be grateful that somebody who's truly a pro will be taking the helm here.

She understands that it's important for the Fed to stay within its statutory authority. That's key to preserving the Fed's political independence. She also understands how critically important it is to use every available tool of government economic policy-making to bring back the economy as fast as possible, because too many families here right now are on the edge of financial catastrophe.

ALEXIS CHRISTOFOROUS: All right, David Wilcox, Senior Fellow at the Peterson Institute. Thanks for being with us today.

DAVID WILCOX: Good to be with you.