Kohn defends Fed lending against "fiscal" charges

The Fed has faced criticism - including from dissenters from within its own ranks - that it has stepped beyond its ambit and undertaken operations that would have been best left to the Treasury, or at least explicitly backed by them.

However, Kohn on Saturday dismissed these claims because the ultimate objective of these operations was in line with its monetary-policy role. "Because of the lack of liquidity, risk-taking and arbitrage in markets, we have been forced to counter tight financial conditions through interventions in particular markets," Kohn said. "But our actions have been aimed at increasing credit flows for the entire economy, and they have been effective in that regard."

He added: "Our large-scale asset purchases of agency securities and agency-guaranteed mortgage-backed securities have helped mortgage markets, but they also appear to have put downward pressure on other long-term interest rates."

But the vice-chair acknowledged that the use of such strategies was questionable and indicated that the Fed should look to avoid taking such steps in future, saying: "Our lender-of-last-resort responsibilities should only involve lending that is appropriately secured. Action taken by the Fed should also aim to improve financial and credit conditions broadly and not to allocate credit to narrowly defined sectors or classes of borrowers, as any decisions to influence the allocation of credit in the role of fiscal policy."

Kohn's defence follows comments in March by Jeffrey Lacker, the president of the Richmond Fed, labelling some of the Fed's lending programmes as "risky" fiscal action.

"Using the Fed's balance sheet is at times the path of least resistance, because it allows government lending to circumvent the Congressional approval process," Lacker said. "This risks entangling the Fed in attempts to influence credit allocation, thereby exposing monetary policy to political pressures."

The Fed's balance sheet has expanded from $874 billion on 1 August 2007 to $2.2 trillion as of 21 May. The composition of the balance sheet has also shifted to include riskier assets such as agency mortgage-backed securities and commercial paper.

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