Monetary policy as triage

 

Think of the central bank as an emergency room doctor with the economy as its patient. This is the analogy used by MIT professor Kristin Forbes at the recent State Street Bank conference. The patient comes in as a different code which determine the severity of the emergency and the requirements for the doctor.

Code Red - The patient is near death and critical condition. Emergency work needs to be done immediately and with urgency. The perfect recent example is the gilt crisis in the UK. There was a major bond crisis which needed attention through purchase of bonds regardless of current policies.

Code Orange - The patient is sick and needs immediate care, but it is not a life-threatening crisis. Providing liquidity through repo and reverse repo could be thought of as a reasonable response to a problem that could turn into a crisis if action is not taken. 

Code Yellow - The patient is coming to the emergency room with ill health, but it does not mean there is a crisis or severe sickness. It is an issue that must be attended to, yet it may not require extra focused attention. In this case, the economy could away from full employment or inflation is away from target and the Fed needs to take action to reach policy goals. The issues can be dealt with through the regular central bank meeting schedule. The patient must be given medicine and treatment. There is a potential problem, but it is not severe if addressed.

Code Blue - There is no serious problem but there needs to be a discussion and action to maintain long-term health. The Fed balance sheet needs to be adjusted back to the core through QT. This is not a crisis, but if no action is taken the health of the patient will turn negative. 

Of course, this analogy assumes the central bank / doctor is not the cause of the problem. The central bank has not taken an oath to do no harm. If the central bank does not stay attentive, you can see how a code blue or yellow can move to orange or red. The central banker always must stay attentive to ensure he does not fail the patient.