Rate Hike Doesn't Change Monetary Policy: Fed's Duke with Reuters

The U.S. central bank was getting back to business as usual by hiking the rate it charges for rarely used emergency loans to banks on Thursday, not warning consumers and businesses to brace for costlier credit, Federal Reserve Governor Elizabeth Duke said.

Elizabeth Duke, Federal Reserve Governor

The hike in the discount rate to 0.75 percent from 0.5 percent, effective Friday, and the earlier ending of some extraordinary credit programs represent "further normalization of the Federal Reserve's lending facilities" and nothing more, said Duke.

"They do not signal any change in the outlook for monetary policy and are not expected to lead to tighter financial conditions for households and businesses," she said in an address at the Economics Club of Hampton Roads, in Norfolk, Virginia, echoing a statement by the Fed when it announced the rate hike earlier.

Duke outlined the wide variety of emergency lending and other measures that the Fed put in place -- some within days of her being sworn in on Aug. 4, 2008 -- at the height of the financial crisis and stressed how vital they have been.

"I wholeheartedly believe that without the actions taken by the Federal Reserve, our financial system would have frozen and the outcome for the economy would have been unthinkable," she said.

In a brief question-and-answer session with the audience afterward, Duke said that in the future the rate of interest that the Fed pays on reserves that banks keep with it likely will become a key policy tool.

"What has happened as a part of this crisis is the Fed funds market has been pretty well disrupted, and so right now there are not many transactions taking place in the fed funds market," she noted.

"There may actually come a time as we transition back to normality where we may have to use that rate rather than the Fed funds rate while the Fed funds market repairs itself."

Duke made clear that some actions that Fed governors had to approve at the peak of the crisis were easier than others, especially the decision to make huge loans to distressed insurer American International Group .

"I wasn't there for Bear Stearns, but I did have to vote on the AIG loan," Duke said. "And I can tell you it was the hardest decision I have ever made."

At the time, she said, panic was so rife in financial markets that it was consuming companies like the monster in an old movie called "The Blob."

"We had just watched it eat Lehman. Now it was focused on AIG," she said. "The clock was ticking, and default was imminent."

The Fed felt it had little choice except to lend to AIG because letting it fail would have "huge" consequences for markets, given its far-flung connections, she said.

"If I had to cast that vote again, even knowing all that followed, including the criticism that we have received, I wouldn't change it," Duke said.

She said the Fed still expects to incur no losses on the loans to AIG.