Policymakers are prepared to do more to help frozen credit markets, Federal Reserve Vice Chairman Donald Kohn said Friday. Speaking at Wooster College in Ohio, Kohn pledged that the Fed would continue to adapt our policies as necessary in order to boost the economy while maintaining price stability.

We have had to remain very flexible and open to policy actions that had no precedent, Kohn said. And all of us--the Federal Reserve, the Administration, and the Congress--must continue in this posture.

The Vice Chairman noted the actions taken by the Fed, including the purchase of $300 billion in longer-term treasury securities as well as buying trillions in toxic bank assets. While the actions taken are promising, financial markets remain under considerable stress, Kohn warned.

Despite this progress, financial markets remain very fragile, lenders are still very protective of their capital and liquidity, risk spreads remain elevated, and many segments--especially securitization markets--continue to be impaired, Kohn said. However, some of the government programs I have discussed--those to restart markets, provide additional capital buffers, and open outlets for legacy assets--are just now being implemented.

While these programs are quite promising, we will not be able to judge their success at restarting lending for a time, he added.

There will be many additional steps before markets normalize, he added. However, as the Fed works to navigate this storm, Kohn noted that they are preparing to offset the possible inflation storm caused by a considerable build up in the Fed's balance sheets.

Because inflation expectations play a key role in the setting of prices and wages, firmly anchored inflation expectations can help avoid both of these outcomes, Kohn said. To help anchor inflation expectations, the FOMC is now providing extended projections of inflation--along with growth and unemployment--in its quarterly economic projections.

In addition, the Federal Reserve must prepare in advance to exit from its bevy of lending programs, Kohn said.

To address concerns about its ability to rein in its balance sheet, the Federal Reserve must be prepared to exit from its various programs when the time is right, he said. Given very large purchases of long-term assets and substantial long-term lending for the TALF and other purposes, the Federal Reserve would benefit from new tools that would allow it to drain reserves from the banking system.

The Fed is working with the Treasury Department in order to gain the tools, Kohn said.

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