For immediate release: September 30, 2009
Dallas Fed: Too Soon to Say Adverse Feedback Loop Broken
DALLAS—Arresting the adverse feedback loop could prove to be the seminal challenge of early 21st century monetary policymaking, according to the latest issue of the Dallas Fed’s Economic Letter.
In “Fed Policy in the Financial Crisis: Arresting the Adverse Feedback Loop,” financial analyst Danielle DiMartino Booth and research analyst Jessica J. Renier explore how the Fed’s recent policy actions have slowed the adverse feedback loop that began when global financial turmoil ended a boom partly fueled by risky mortgage lending.
In 2008, the Federal Open Market Committee defined an adverse feedback loop as “a situation in which a tightening of credit conditions could depress investment and consumer spending, which, in turn, could feed back to a further tightening of credit conditions,” according to the authors.
Using a combination of conventional and unconventional policies, the Fed attacked the adverse feedback loop aggressively, DiMartino Booth and Renier say. While the economy’s decline has slowed and positive signs are emerging in financial markets, housing and manufacturing, it’s too soon to say that the adverse feedback loop has been broken.
Several dangers still lurk, including bad debt still on institutions’ balance sheets, downward pressure on consumer spending and company revenues, and home loan modifications that may simply stall foreclosures, the authors state.
“High foreclosure rates perpetuate the adverse feedback loop, but they may be a necessary price to pay to unravel the housing market’s excesses,” they write. “By forcing home prices to more sustainable levels, foreclosures play an important role in clearing markets.”
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