The Federal Reserve’s (the Fed’s) policies aren’t what they used to be, and that’s a good thing. John C. Williams, president and chief executive officer (CEO) of the Federal Reserve Bank of San Francisco (FRBSF) addressed the new monetary policy and lending tools employed by the Fed during the Great Recession in his presentation to the American Economics Association (AEA) National Conference in June 2011.

Among his discourse on the history of payment technology, Mr. Williams explained the Fed has implemented policies that aren’t always kosher with traditional economic theory because money has evolved from a hard-to-access, cash- or check-only existence to the ease of swiping a credit card or logging into PayPal. This evolution has forever changed the way the money supply waxes and wanes, which has thus profoundly impacted the Fed’s playbook in times of recession. [For more information regarding the Fed’s role in a recession, see the June 2011 first tuesday article, Suspect behavior: why and how the Fed creates a recession.]

For example, the Fed has added $1.5 trillion to banking reserves since December 2007 in an effort to increase the availability of credit, drive private-sector and depositor rates down, allow lenders to make massive profits (no cost for money) and, in the process, stimulate jobs for improving the economy.

Traditional economic theory says lenders would much rather lend out excess reserves than hold them and miss an opportunity to earn a return on their loans. However, this does not currently seem to be the case.

Even though the Fed increased bank reserves plus currency by 200% in the past few years, lenders are still choosing to hold their reserves instead of lend them out due in part to the murky economic climate. This trend is not likely to change once the economy stabilizes, because 2008 legislation authorized the Fed to pay interest on bank reserves — which they currently do.

Lenders who receive interest on the money they’re holding in reserve on deposit with the Fed feel much less pressure to lend it out, especially when the economy is still recovering.

Bank reserves were also increased when the Fed purchased $1.7 trillion in longer-term securities from 2008 to June 2011. These purchases increased the demand for longer-term securities, which pushed up their prices and lowered longer-term interest rates. The longer-term securities purchase programs are projected to raise the gross domestic product (GDP) by 3% and add roughly 3 million jobs by late 2012. [For more information regarding the Fed’s monetary policy, see the March 2011 first tuesday article, Home financing, mortgage-backed bonds and the Fed.]

Mr. Williams concluded by highlighting the changes in the Fed’s role as lender of last resort. Traditionally, the Fed uses the discount window to lend cash to banks against illiquid collateral in times of financial crisis. Recently, the Fed extended the discount window to institutions other than banks — such as an insurance company — and lent cash against a wider variety of illiquid assets. As the financial system has grown more complex, the Fed has adapted and innovated new ways to fulfill their role.

first tuesday take: We could not have said this better than Mr. Williams did in his address, a huge improvement over his predecessors’ speeches. We encourage our readers to follow the referenced link and read his full address, which clearly details the Fed’s role in our economy. The Fed is fully transparent to anyone willing to read.

We will add, however, criticism for the Fed’s past fast and easy monetary policies prior to 2004 and the payment of too high a rate of interest on reserves placed with the Fed. When a tighter leash is kept on the roll of money they create, economic booms will be less violent, busts less vicious and recovery less painful.

Re: “Economics Instruction and the Brave New World of Monetary Policy” from the Federal Reserve Bank of San Francisco