Michael S Barr: The intersection of monetary policy, market functioning, and liquidity risk management

Speech by Mr Michael S Barr, Vice Chair for Supervision of the Board of Governors of the Federal Reserve System, at the 40th Annual National Association for Business Economics (NABE) Economic Policy Conference, Washington DC, 14 February 2024.

The views expressed in this speech are those of the speaker and not the view of the BIS.

Thank you for having me here today. After having had to miss this conference last year, I greatly appreciate the opportunity to join you. As you might expect, I was a little busy in March 2023, and I will share some thoughts on lessons learned from the stress in the banking system at that time, in particular what we have learned in terms of liquidity risk management.

But first, I will start by discussing recent economic developments and the implications for monetary policy. I will then turn to the banking sector and will focus on some topics that lie at the intersection of the composition of the Fed's balance sheet, market functioning, bank liquidity risk management, and the Fed's role in liquidity provision.

Starting with economic developments, I think it is helpful to reflect on how surprised most watchers of the economy were by developments in 2023, me included.

Perhaps like many of you, at the start of 2023 I had projected that tighter monetary policy would cause a slowdown in both inflation and economic activity. Then, with the March 2023 banking stress, I was concerned that a potential credit contraction could further weaken the economy.

At the same time, I also worried that inflation might remain elevated, even if we had weaker economic activity, as supply chain problems and job-matching challenges continued to be prominent elements of the pandemic's disruption to the operation of our economy.

I am glad to say that those worries did not come to pass, in part due to the official sector response to the banking stress, sound monetary policy, and a healing economy. Economic activity expanded at a solid pace, the labor market remained strong, and inflation came down significantly.

Disinflation and a growing economy

The current mix of outcomes we are experiencing would have seemed improbable one year ago, and we might ask, how did we end up with disinflation and an economy with brisk growth? The short answer is the healing of the economy. The pandemic brought our economy to a screeching halt. During the second quarter of 2020, the unemployment rate jumped to a high of 14.8 percent and gross domestic product plunged at a 28 percent annual pace. These dynamics hit some of the most vulnerable populations the most, though strong government responses helped to both ease the effects and make many households much more resilient. Once the economy restarted, demand rebounded quickly, while supply was hampered by supply chain difficulties. These supply snags were compounded enormously by a shift in demand away from in-person services and toward goods, which generally have a larger exposure to shipping and supply chain problems. Supply shocks to the global economy were subsequently compounded by Russia's war against Ukraine, which severely disrupted food and energy markets. And labor markets were disrupted by the pandemic as well. Employers could not find enough workers, and job-matching was impaired.